Question

Which of the following portfolios of two assets would be preferred by a risk averse investor OA. Outcome I, Pr-0.50: When asset A increases in value, asset B does not change in value Outcome II, Pr-0.50:When asset A does not change in value asset B decreases in value O B. Outcome I, Pr=0.50: When asset A increases by $10.asset B decreases on average by 55 Outcome II, Pr-0.50: When asset A decreases by 58, asset B increases on average by $9 O C. Outcome 1, Pr-0.50: When asset A increases by $10, asset B decreases by $10 Outcome II, Pr-0.50: When asset A decreases by $5, asset B increases by $5. Outcome. PrW0.50: When asset Aincreases in value asset B increases by the same amount Outcome II, Pr 0.50:When asse A decreases in value, ass B decreases by the same amount

Answer 1

Option C is correct. Risk averse person is the one who is reluctant to take risk. An investor who prefers lower returns with known risks rather than higher returns with unknown risks.

In outcome 1, probability is 0.5. The increase in value of A $10 * 0.50 = $5. And decrease in value of B = $10 * 0.50 = -$5. Therefore the expected payoff is zero.

In outcome 2, probability is also 0.5. The decrease in value of A = $5 * 0.5 = -$2.5. And increase in value of B = $5 * 0.5 = ​​​​​​$2.5. In this case also, the expected pay off is zero.

This option is to be best for the investor, as if he is not gaining from the investment also he is not loose anything. While with the other options at the end he left with the uncertainty og gaining or loosing.

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