Compute the expected return, standard deviation, and value at risk for each of the following investments:
Investment (A): Pays $800 three-fourths of the time and a $1,200 loss otherwise. Investment (B): Pays $1,000 loss half of the time and a $1,600 gain otherwise.
State which investment will be preferred by each of the following investors and explain why.
(i) a risk-neutral investor
(ii) an investor who seeks to avoid the worst-case scenario.
(iii) a risk-averse investor.
Answer part A
Investment (A)
The expected return is,
The standard deviation,
Value at risk,
Investment (B)
Expected return,
Standard deviation,
Value at risk,
Part B
1)
The risk neutral investors means the indifference between these two investments because they pay the same expected return.
2.
Suppose the investor seeks to avoid the worst scenario, then he will choose B.because it has lower risk value.
3.
If the investor is risk averse then he will choose investment A, it is because lower standard deviation. It is because has less uncertainty about the expected return relative to investment B.
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