Question

You are considering two alternative two-year investments: You can invest in a risky asset with a positive risk premium and returns in each of the two years that will be identically distributed and uncorrelated, or you can invest in the risky asset for only one year and then invest the proceeds in a risk-free asset. Which of the following statements about the first investment alternative (compared with the second) are true?a. Its 2-year risk premium is the same as the second alternative.b. The standard deviation of its 2-year return is the same.c. Its annualized standard deviation is lower.d. Its Sharpe ratio is higher.e. It is relatively more attractive to investors who have lower degrees of risk aversion.

Answer 1

Answer:

The correct answers from the options are options C and E

Explanation:

Here, the first investment alternative depicts an investment in a risky asset with a positive risk premium and returns (dividends) for each of the two years that will be evenly distributed. Therefore, the following statements are true about the first investment alternative compared to the second;

i)  Its annualized standard deviation is lower, and

ii) It is relatively more attractive to investors who have lower degrees of risk aversion.