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Return and Risk Solution

Return and Risk Solution - FINA 3104 Practice Problems Fall...

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1 FINA 3104 Practice Problems Fall 2011 Two Determinants of Investment Decisions: Return and Risk (Suggested Solution) 1. True or False (Briefly Explain) (a) A risk-loving investor is willing to accept lower expected returns in exchange for higher risk. Solution: TRUE. A risk-loving investor prefers both higher expected returns and higher risk; both give utility to the investor. In other words, to stay at the same level of utility, the risk-loving investor is willing to accept lower expected return if a higher risk is given. (b) In deciding which funds to invest, we should use geometric average returns because fund managers typically reinvest dividends and other income. Solution: FALSE. We should use arithmetic average returns because these are unbiased estimates of expected future returns. In deciding which mutual funds to invest, we care about future returns. (c) A risk-averse investor dislikes risk and always chooses to invest in the riskfree asset.
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