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Consider two well-diversified portfolios. Portfolio 1 has an expected return of 8% and three-quarters average market risk while portfolio 2 has an expected return of 12% and a beta of 1.50. If the risk-free rate is 2.5%, which portfolio would a rational risk- averse investor prefer and why?

Respuesta :

letmeanswer

Portfolio 1 is to be chosen

Explanation:

The following formula is used to calculate the reward to risk ratio.

Reward-to-Risk ratio = (Expected Return - Risk free Rate)/Beta

For Portfolio 1,

Reward-to-Risk ratio = [tex](8 \%-2.5 \%) / 0.75=0.073333[/tex]

For Portfolio 2,

Reward-to-Risk ratio = [tex]=(12 \%-2.5 \%) / 1.50=0.063333[/tex]

Rationale risk investor would chhose portfolio 1 since it has higher reward to risk ratio

Note: the beta of portfolio 1 is taken as 3 by 4 which comes to 0.75

bhuvna789456

Portfolio 2 would be preferred by all the people and the investor because it has the highest return ratio percentage.                                      

Explanation:

  • Portfolio 1 has a return of 8 percentage and three-quarters average risk. On the other hand, portfolio 2 has a return of 12 percentage and it has a beta of 1.50. Portfolio 1 has a lesser percentage return than portfolio 2.
  • So Portfolio 2 would be preferred as the first option. Because portfolio 2 has a higher percentage of the reward risk ratio. So it will be preferred.