Question

1. Mark is an active portfolio manager at a money management firm focusing exclusively on long equities. David is the risk manager for the firm.

	Portfolio 1	Portfolio 2	Portfolio 3
Expected Return	3.2%	6.4%	5.4%
Standard Dev	1.0%	2.0%	5.0%

1. Mark is adamant that the firm invest in Portfolio 3 while David is pushing for Portfolio 2. What is Mark’s risk preference? Why? What is David’s risk preference? Why?
2. In making a choice between Portfolio 1 and Portfolio 2, Mark is adamant about Portfolio 2, while David is indifferent between Portfolio 1 and Portfolio 2. Who is exhibiting rational investor behavior? Why?

Answer 1

a) Portfolio 3 has a high risk -high return profile while portfolio 1 has a low risk- low return profile therefore Mark is more risk loving while David is more risk averse.

b) Comparing the risk adjusted return of the portfolio 1 and 2 whe can calculate teh below ratio:

For portfolio 1 it is

For portfolio 2 it is

Mark is pushing for 2 because he thinks that it is giving a higher return and he is not considering the increase in risk while when comparing the return to risk raito, the ratio is the same for both the portfolios and therefore the reason for David being indifferent between the two portfolios. So David is being rational while Mark is being irrational.