Question

Two assets have the following expected returns and standard deviations when the risk-free rate is 5%:

Asset A: Expected return = 10% & SD = 20%
Asset B: Expected return = 15% & SD = 27%

An investor with a risk aversion of A = 3 would find that _________________ on a risk return basis.

a. only Asset A is acceptable
b. only Asset B is acceptable
c. neither Asset A nor Asset B is acceptable
d. both Asset A and Asset B are acceptable

Answer 1

c. neither Asset A nor Asset B is acceptable

Explanation:

The computation of the risk return basis is shown below:-

Optimal Return of Asset A is

= A × 0.5 × Standard Deviation^2 + Risk Free Rate

= 3 × 0.5 × 20%^2 + 5%

= 11%

As 10% is lesser than 11%

Now

Optimal Return of Asset B is

= A × 0.5 × Standard Deviation^2 + Risk Free Rate

= 3 × 0.5 × 27%^2 + 5%

= 15.94%

As 15% is lesser than 15.94%

Therefore neither Asset could be acceptable