Question

Investment A has an expected return of 14% with a standard deviation of 4%, while investment B has an expected return of 20% with a standard deviation of 9%. Therefore:__________
a. A rational investor will pick investment B because the return adjusted for risk (20% - 9%) is higher than the return adjusted for risk for investment A ($14% - 4%).
b. A risk averse investor will definitely select investment A because the standard deviation is lower.
c. it is irrational for a risk-averse investor to select investment B because its standard deviation is more than twice as big as investment A's, but the return is not twice as big.
d. rational investors could pick either A or B, depending on their level of risk aversion.

Answer 1

Answer:

d. rational investors could pick either A or B, depending on their level of risk aversion

Explanation:

In making investment decisions investors use various analysis to make an informed decision on which assets will suit their needs.

Two of such analysis are returns standard deviation.

Returns shows the percentage of original investment that is expected to come back as profit.

Standard deviation is the tendency of investment performance to deviate from a mean value.

The higher the standard deviation the more the risk of getting low returns or getting higher profit. This is well suited to risk takers.

The lower the standard deviation the less variance from a mean value, so risk averse investors will prefer this.

In the given scenario risk averse investors will prefer Investment A with expected return of 14% with a standard deviation of 4%. Because of the low standard deviation.

Risk takers will prefer investment B with expected return of 20% with a standard deviation of 9%. Because of the higher standard deviation.