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Unformatted text preview: FEEDBACK FORUM TOPIC 5 RISK AND RETURN PART 1 Question 1 The return and associated probabilities of two assets in each of 3 possible states is given below. The probabilities are of each state occurring. State I II III Asset A 10% 7% 6% B 5% 8% 9% Probability: 25% 50% 25% The return and variance of assets A and B are: A) Ra= 7.5; Rb = 7.5; Var A = 1.5; Var B = 1.5 B) Ra= 7.5; Rb = 7.5; Var A = 2.25; Var B = 2.25. C) Ra= 7; Rb = 7.5; Var A = 2.25; Var B = 2.25. D) none of the above ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 n n i PR R PR R PR R R + + + = ..... 2 2 1 1 ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 % 5 . 7 075 . 015 . 035 . 025 . 25 . 06 . 50 . 07 . 25 . 10 . = = + + = + + = A R ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 % 5 . 7 075 . 0225 . 04 . 0125 . 25 . 09 . 50 . 08 . 25 . 05 . = = + + = + + = B R ( 29 ( 29 i i i i PR R R Var 2 = ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 25 . 075 . 06 . 50 . 075 . 07 . 25 . 075 . 10 . 2 2 2 + + = A Var = 0.00015625+0.0000125+0.00005625 = 0.000225 = 0.0225% ( 29 ( 29 ( 29 ( 29 ( 29 ( 29 25 . 075 . 09 . 50 . 075 . 08 . 25 . 075 . 05 . 2 2 2 + + = B Var = 0.00015625+0.0000125+0.00005625 = 0.000225 = 0.0225% 1 Question 2 The return and associated probabilities of two assets in each of 3 possible states is given below. The probabilities are of each state occurring. State I II III Asset A 10% 7% 6% B 5% 8% 9% Probability: 25% 50% 25% Which asset would a risk averse investor choose? A) asset A B) asset B C) indifferent between A and B D) depends upon the investor's degree of risk aversion % 15 . %, 0225 . %, 5 . 7 %, 15 . %, 0225 . %, 5 . 7 = = = = = = B B B A A A Var R Var R A riskaverse investor will only accept higher risk if there is the possibility of a higher return (riskreturn tradeoff). And a rational, riskaverse investor will aim for the highest return for a given level of risk, or lowest risk for a given return. Therefore, since the expected return for both Asset A and Asset B is the same and they have the same variance and standard deviation, a rational, riskaverse investor would be indifferent between the two assets. 2 Question 3 A riskaverse investor is faced with a selection between Asset A with a standard deviation of 20% and an expected return of 15%, and Asset B with a standard deviation of 25% and an expected return of 20%. Which asset would the investor prefer? A) Asset A B) Asset B C) depends upon the investor's level of risk aversion D) indifferent between A and B % 25 %, 20 %, 20 %, 15 = = = = B B A A R R Asset B has a higher expected return and...
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 Three '10
 MichaelGangemi

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