Question

1. A situation exists in which there are the following five investment possibilities. investment expected return risk A 6.50% 1.90% B 10.11% 11.50% С 7.54% 8.42% D 9.42% 12.65% E 7.00% 1.60% What can we say about the choice of a risk-averse, risk-loving, and risk-neutral individual? Explain. (12 points).

Answer 1

A risk averse investor will avoid any risk taking and is not ambitious enough for higher returns. They prefer stability and are satisfied with a reasonable return. Based on the nature, a risk averse investor will prefer investment A and investment E because of their low risk. Investment A has a risk of 1.90% with a return of 6.50% and investment E has a risk of 1.60% and a return of 7.00%, which are lowest among all the investments opportunities given here.

A risk loving investor prefer to take risky chances in expectation of higher returns. These type of investors are not satisfied with reasonable returns. They are willing to take risk on investments Greater market uncertainty and market fluctuation is what they seek in anticipation of higher returns. Based on this, a risk taking investor will opt for investment B and investment D. Investment B has a risk of 11.50% with return of 10.11% and Investment D has a risk of 12.65% with a return of 9.42%

A risk neutral investor perefer to maximize their returns. They are aware of the risks but the focus is more on potential gains. A risk neutral investor is indifferent between a lottery and a guaranteed return. Based on such a nature, a risk neutral investor will opt for Investment C that has a risk of 8.42% and return of 7.54%. By taking some added risk, the risk neutral investor is earning a higher return than a risk averse investor.