Question

A has an expected return of 10% and a standard deviation of 5%.

B has an expected return of 14% and a standard deviation of 4%.

C has an expected return of 17% and a standard deviation of 8%.

If the investor does not want to fall below 7% which investment would be the best choice using Roy's rule?

Answer 1

The Roy's rule of Safety first criteria measures the minimum required return in comparison to it's risk.

It is calculated by the formulae

Roy's Safety first  Ratio = (Expected return - Minimum return) / Standard deviation

So, we will evaluate all the returns,

A - Roy's Safety first  Ratio = (10% - 7%) / 5%

= 3% / 5%

= 0.60

B - Roy's Safety first  Ratio = (14% - 7%) / 4%

= 7% /4%

= 1.75

C - Roy's Safety first  Ratio = (17% -7%) / 8%

= 10% / 8%

= 1.25

So, The according to the roy's rule Project B should be selected as it has highest ratio.