Asked by Shreyans Nanavati on Jul 07, 2024
Verified
Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ________.
A) asset A
B) asset B
C) no risky asset
D) The answer cannot be determined from the data given.
Reward-to-Variability Ratio
This ratio, often called the Sharpe ratio, measures the return of an investment relative to its risk, whereby a higher ratio indicates a more desirable outcome.
Risk-Free Asset
An investment perceived to have no risk of financial loss, often exemplified by government bonds.
Expected Return
The anticipated return on an investment based on the probabilities of various outcomes, factoring in both potential gains and losses.
- Identify and calculate the reward-to-variability ratio and its significance in investment decisions.
- Understand the role of risk aversion in portfolio selection and asset allocation.
Verified Answer
PK
Prateek kadambandeJul 14, 2024
Final Answer :
A
Explanation :
A risk-averse investor who prefers a portfolio using a risk-free asset will want to invest in the asset with the highest reward-to-variability ratio among risky assets. In this case, Asset A has a higher reward-to-variability ratio (.4 > .3) while still offering a relatively high expected return of 15%, making it the better choice for a risk-averse investor.
Learning Objectives
- Identify and calculate the reward-to-variability ratio and its significance in investment decisions.
- Understand the role of risk aversion in portfolio selection and asset allocation.