CFA Practice Question

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CFA Practice Question

Three investors Jen, Sarah, and Matt, are considering two investments: A and B. Investment A is the less risky of the two investments, requiring an outlay of $5,000 with an expected rate of return of 12%. Each investor is satisfied with this expected return. Investment B also requires an investment of $5,000 and has an expected return of 12% but appears to have considerably more variability in potential returns than A. Jen now requires a return of 16%, Sarah is still satisfied with 12%, and Matt seeks only an 8% expected return.

Given the information above, which of the three investors would be considered risk-averse?
A. Jen
B. Jen and Sarah
C. Sarah and Matt
Explanation: Only Jen would be considered risk-averse. She is the only investor that demands a risk premium to entice her into this riskier venture. Sarah would be considered risk-neutral as she is content with the same rate of return despite the higher risk levels and Matt would be considered a risk seeker as he is demanding a return that is less than the return offered for a lower risk investment.

User Contributed Comments 5

User Comment
kalps think about the slope for percentage change is risk - retun is most for Jen - i.e. she has a steeper curve than others hences more risk averse
dealsoutlook good question
jnptrsn1 This question said that the three were satisfied with investment A, then laid out the potential investment in B. I didn't see it suggesting that any of the three investors would be investing in it, only that they had more options for potential investments. Am I missing something here?
dylanmaney This question doesn't make any sense. If Jen demands a higher rate of return, she will seek it through riskier investments. She is the least "risk-averse" of the three. Can someone walk me through this?
dbalakos THe question wants to imply that they are investing in B. Jen is not satisfied because she saw investment A having the same return with less risk and requires a greater return from B to compensate herself for the additional risk. She is thus risk averse. Sarah does not care and Mat gains utility from additional risk as a risk lover and is satisfied with even less return than before
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