Question

1. Aminah, the financial manager for the financial manager for Hills Ltd., wishes to evaluate three prospective investment X, Y, Z. Aminah, evaluate each of these investments to decide whether they are superior to investments that his company already has in place, which have an expected return of 10% and a standard deviation of 5%. The following table shows the expected returns and standard deviations of the investments

Investment	Expected return	Standard deviation
X	18%	8%
Y	10	9
Z	8	10

1. If Aminah were risk neutral, which investment would he select? Explain why
2. If she risk averse, which investment would he select? Why?
3. If he were risk seeking, which investments would he select? Why?
4. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?

Answer 1

a. Risk neutral

The Aminah will select investment X as it has highest return. The risk does not matter for the risk neutral investor.

b. Risk averse

A risk averse investor prefers lower risk over higher risks.

The Aminah will select investment X as it has lowest Risk.

c. Risk seeking investor

A risk seeking investor prefers higher risk over lower risks.

The Aminah will select investment Z  as it has highest Risk.

d.Traditional risk preference financial managers

Traditional risk preference financial managers will select Investment X. as it provides higher return with lower risk.