Question

Consider an economy consisting of two stocks (X and Y) and a risk-free asset. Investor A...

Consider an economy consisting of two stocks (X and Y) and a risk-free asset. Investor A maximizes his utility function by investing 10% of his wealth in the risk-free asset, 75% in X, and 15% in Y. Investor B maximizes his utility function by investing 40% of his wealth in the risk-free asset. What fraction of his wealth does investor B invest in X?

A.

15%
B.

60%
C.

37.5%
D.

50%
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Answer #1

Investor A has maximised his utility by investing maximum in Stock X (75%)and minumum in risk free asset (10%) which shows that he is NOT a risk averse person. He infact loves risk. Thus, we can safely assume that Stock Y is also less risky compared to X.

However, investor B has invested 40% in risk free asset which means he is a risk averse person. The remaining of his portfolio i.e., 60% is to be divided btween stock X & Y. He will choose to invest maximum in Y and minimum in X. Thus he will invest the least of all the given options available i.e., 15% in stock X and remainder i.e., 45% in stock Y.

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