Question

Risk preferences Sharon Smith, the financial manager for Barnett Corporation, wishes to select one of three prospective investments: X,Y, and Z. Assume that the measure of risk Sharon cares about is an asset's standard deviation. The expected returns and standard deviations of the investments are as follows:

Investment Expected return Standard deviation

X 14% 7%

y 14% 8%

z 14% 9%

a  If Sharon were risk neutral, which investment would she select? Explain why.

b. If she were risk averse,which investment would she select? Why?

c. If she were risk seeking, which investments would she select? Why?

d. Suppose a fourth investment, W, is available. It offers an expected return of15 %, and it has a standard deviation of 9%. If Sharon is risk averse, can you say which investment she will choose? Why or why not? Are there any investments that you are certain she will not choose?

Answer 1