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How a risk neutral investor allocates her asset between a risk free security and a risky...

How a risk neutral investor allocates her asset between a risk free security and a risky asset. The risk-free return is 5% and the return of the risky asset is 7% with a standard deviation of 4%.

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Answer #1

Risk neutral investors focus only on the expected return when making investment decisions. The level of risk is not considered by risk neutral investor when making investment decision.

Hence, in given case, a risk neutral investor allocates all her assets (100%) into risky assets as return on risky asset i.e. 7% is more than the return on risk free asset i.e. 5%.

The standard deviation of risky asset is irrelevant to risk neutral investor while allocating her assets.

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