CFA Practice Question

There are 294 practice questions for this study session.

CFA Practice Question

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 ______

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.
Correct Answer: A

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.
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