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"Risk and Return" Please respond to the following: As a financial manager, determine at what point...

"Risk and Return" Please respond to the following:

  • As a financial manager, determine at what point the risk-free rate of an investment outweighs the risk premium. Provide support for your rationale.
  • Explain whether you believe an investor should invest in risky and riskless assets. Support your answer with an example.
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Answer #1

Risk free rate of an investment outweighs the risk premium when the beta of an asset is 0. This can be checked through CAPM.

As per CAPM expected return = Risk free rate + Beta * Market premium

If Beta is zero , expected return is the risk free rate itself. At this point where there is no volatility for an asset the reward is same as a an asset that has no risk.

One must invest in a combination of risky and riskless assets based on the risk appetite. If one has high risk appetite, he must invest more in risky assets and a lesser proportion in risk free assets in order to set off any losses due to high risk assets. If one has low risk appetite, he must invest more in risk free assets and less in risky assets. Ideally one must invest in a healthy proportion of risky and riskless assets to gain rewards of risk taking, compensate for time value of money.

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