Question

Investment A has a standard deviation of 12% and an expected return of 10%. Investment B has a standard deviation of 18%, but an expected return of 12%. Which project is preferable from a risk return point of view? Please answer quantitatively, by calculating the coefficient of variation of the investments.

Answer 1

Coefficient of Variation(CV) is a measure of volatility or risk and explains how much risk one is taking for the given return.

CV= Standard deviation_{/Average/Expected Return}

Investment A:
Statndard Deviation: 12%
Expected Return= 10%

CV= 12%/10% = 1.2
CV for Investment A is 1.2

Investment B
Statndard Deviation: 18%
Expected Return= 12%
CV= 18%/12% = 1.5
CV for Investment B is 1.5

Since the coefficient of variation gives the risk/return ratio, the lower the ratio the lower will the risk per return so in this case Investment A with CV=1.2 is a good option to invest