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Basic Question 2 of 22
Investments A and B both offer an expected rate of return of 12%. If the standard deviation of A is 20% and that of B is 30%, then investors would prefer ______
B. B to A
C. a portfolio of A and B
D. We cannot answer the question without knowing the investor's risk preferences.
A. A to B
B. B to A
C. a portfolio of A and B
D. We cannot answer the question without knowing the investor's risk preferences.
User Contributed Comments 16
| User | Comment |
|---|---|
| stefdunk | a risk seeking investor would actually prefer B over A. so, without knowing an investor's risk preferences, we can't answer this. therefore the correct answer is D |
| johnsk | You have to assume the all investors are risk-averse, otherwise many financial principles would not be valid: investors care about risk. |
| kveerag | Everything remaining the same, the hypothesis in portfolio management is that investors will always be risk-averse |
| gizi | A risk seeking investor assuming that he is smart will still not chose B over A because the return is the same. He would only chose B if the expected return was greater. Why take on more risk for the same return! |
| GiriJoshi | For a given expected return, investors will always go for an investment that is less risky. |
| MUTE | Investors will always bid for less risky investment |
| DonAnd | the correct answer is A (prefer A to B) as A has the least amount of risk (s.d of 20%) for the same level of return as B. |
| pporres | And what about the risk seekers commented on de LOS? |
| michlam14 | this is clearly a question on risk aversion, i would have thought they expected us to apply the knowledge from the section and hence I picked D, which is not incorrect either in the theoretical sense? |
| moneyguy | It makes sense. If B had a higher expected return, a less risk averse investor may choose B. |
| johntan1979 | Come on, you guys! Both A and B offer the SAME reward. A has a lower sd, meaning the chances of getting the reward is higher than B. Who in the right mind will choose B, whether you are risk-averse or risk-seeker??? |
| jonan203 | an options trader who is looking to short theta would obviously choose investment B as the premium would be higher and he would make more money on the decay. question should say, "all else equal, a risk AVERSE individual would choose ___" |
| geofin | STD of a stock shouldn't matter since most of it is diversifiable. So, B might have lower beta even with much higher std. In this case investors would clearly prefer B to A (think of gold -highly volatile but very low beta) |
| houstcarr | You're wrong Johntan, just look at the notes. Any investor, risk averse or risk seeking, prefers the investment/portfolio that provides a higher level of utility (the higher indifference curve). For two investments with an equal expected return, the risk seeking investor achieves higher utility from the higher standard deviation, since his risk aversion coefficient is negative. Understanding this was the whole point of the LOS, therefore the answer should be D. |
| chesschh | I think it should be D std dev measures dispersion, so a risk seeker may prefer B if he is willing to get a higher risk. Example: Portfolio A: 0,2,4,6,8,10,12,14,16,18,20,22,24 Portfolio B: 0,12,24 Both have the same expected return with a different std dev. Some people are willing to choose B |
| khalifa92 | in CFA all investors are risk averse unless mentioned otherwise. it's like speaking about US GAAP or IFRS, its IFSR unless US GAAP was mentioned. |
I passed! I did not get a chance to tell you before the exam - but your site was excellent. I will definitely take it next year for Level II.
Tamara Schultz
Learning Outcome Statements
explain risk aversion and its implications for portfolio selection;
CFA® 2024 Level I Curriculum, Volume 5, Module 62.