- CFA Exams
- CFA Level I Exam
- Topic 9. Portfolio Management
- Learning Module 62. Portfolio Risk and Return: Part I
- Subject 4. Risk Aversion and Portfolio Selection
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 |