Question

Assume that a new law is passed which restricts investors to holding only one asset. A risk-averse investor is considering two possible assets as the asset to be held in isolaiton. The assets' possible returns and related probabilities are as followsAsset X Asset Y Pr Rx Pr Ry.10 -3% .05 -3%.10 2 .10 2.25 5 .30 5.25 8 .30 8.30 10 .25 10Which asset should be preferred?a. Asset X, since its expected return is higher.b. Asset Y, since its beta is probably lower.c. Asset Y, since its coefficient of variation is lower and its expected return is higher.d. Asset X, since its standard deviation is lower.e. Either one, since the expected returns are the same.

Answer 1

Answer:

(C) Asset Y, since its coefficient of variation is lower and its expected return is higher

Explanation:

Given the various probabilities (P) and returns (R) for Asset X and Asset Y, their expected return is computed as follows.

Asset X = $Summation(P_{r} *R_{x} )$

= (0.1*-3%) + (0.1*2%) + (0.25*5%) + (0.25*8%) + (0.3*10%)

Expected return (Asset X) = 6.15%

Asset Y = $Summation(P_{r} *R_{y} )$

= (0.05*-3%) + (0.1*2%) + (0.3*5%) + (0.3*8%) + (0.25*10%)

Expected return (Asset Y) = 6.45%.

Due to its higher expected return, Asset Y should be preferred.

The answer is option C because it contained a statement that Asset Y has a higher expected return.

Option (B) is wrong because we are not certain if Asset Y has a lower beta. We were not given any information to compute the beta.

Options (A), (D) and (E) are wrong because they did not specify Asset Y has the preferred asset.