Reading 50: An Introduction to Portfolio Management LOS a习 evidence, following, statements, 2010

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LOS a: Define risk aversion and discuss evidence that suggests that individuals are generally risk-averse.

Which of the following statements about risk aversion is TRUE?

A) Risk averse investors will not take on risk.

B) Risk aversion implies that the risk-return line, the CML, and the SML are downward sloping curves.

C) Given a choice between two assets with equal rates of return, the investor will always select the asset with the lowest level of risk.

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Risk aversion implies that an investor will not assume risk unless compensated.

 

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The basic premise of the risk-return trade-off suggests that risk-averse individuals purchasing investments with higher non-diversifiable risk should expect to earn:

A) lower rates of return.

B) rates of return equal to the market.

C) higher rates of return.

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Investors are risk averse.  Given a choice between two assets with equal rates of return, the investor will always select the asset with the lowest level of risk.  This means that there is a positive relationship between expected returns (ER) and expected risk (Es) and the risk return line (capital market line [CML] and security market line [SML]) is upward sweeping.

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Which of the following statements is NOT consistent with the assumption that individuals are risk averse with their investment portfolios?

A) Many individuals purchase lottery tickets.

B) Higher betas are associated with higher expected returns.

C) There is a positive relationship between expected returns and expected risk.

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Investors are risk averse. Given a choice between two assets with equal rates of return, the investor will always select the asset with the lowest level of risk. This means that there is a positive relationship between expected returns (ER) and expected risk and the risk return line (capital market line [CML] and security market line [SML]) is upward sweeping. However, investors can be risk averse in one area and not others, as evidenced by their purchase of lottery tickets.

honeycfa

Risk aversion means that if two assets have identical expected returns, an individual will choose the asset with the:

A) lower risk level.

B) higher standard deviation.

C) shorter payback period.

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Investors are risk averse.  Given a choice between assets with equal rates of expected return, the investor will always select the asset with the lowest level of risk.  This means that there is a positive relationship between expected returns (ER) and expected risk (Es) and the risk return line (capital market line [CML] and security market line [SML]) is upward sloping.

Standard deviation is a way to quantify risk. The payback period is used to evaluate capital projects, not investment returns.

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Which of the following statements about portfolio diversification is TRUE?

A) When a risk-averse investor is confronted with two investment opportunities having the same expected return, the investor will take the opportunity with the lower risk.

B) The efficient frontier represents individual securities.

C) As the correlation coefficient moves from +1 to zero, the potential for diversification diminishes.

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The other statements are false. The lower the correlation coefficient; the greater the potential for diversification. Efficient portfolios lie on the efficient frontier.

honeycfa

Which of the following statements best describes risk aversion?

A) There is an indirect relationship between expected returns and expected risk.

B) Given a choice between two assets of equal return, the investor will choose the asset with the least risk.

C) The investor will always choose the asset with the least risk.

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Risk aversion is best defined as: given a choice between two assets of equal return, the investor will choose the asset with the least risk. The investor will not always choose the asset with the least risk or the asset with the least risk and least return. As well, there is a positive, not indirect, relationship between risk and return.