Question

11. Consider a Treasury bill with a rate of return of 2.5% and the following risky securities: Security A: E(r) = .14; variance = .0400 Security B: E(r) = .13; variance = .0225 Security C: E(r) = .12; variance = .1000 Security D: E(r) = .11; variance = .0625 The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor should choose as part of her complete portfolio to achieve the best CAL would be ________, while security ______ should be avoided.

Answer 1

The security the investor should choose as part of her complete portfolio to achieve the best CAL would be Security B, while security Security C should be avoided.

Coefficient of variance of Security A = Standard deviation / Expected return = Sqrt(0.040) / 14% = 20% / 14% = 1.43

Coefficient of variance of Security B = Standard deviation / Expected return = Sqrt(0.0225) / 13% = 15% / 13% = 1.15

Coefficient of variance of Security C = Standard deviation / Expected return = Sqrt(0.1000) / 12% = 31.62% / 12% = 2.64

Coefficient of variance of Security D = Standard deviation / Expected return = Sqrt(0.0625) / 11% = 25% / 11% = 2.27

Decision making lower the CoV the better thus Security B is selected for sure and security C is avoided for sure