20) 20) You are going to invest all of your funds in one of three projects with

Question

20) 20) You are going to invest all of your funds in one of three projects with the following distribution of possible returns: Project 1 Standard Deviation 12% Probability 50% Chance 50% Chance Project 2 Standard Deviation 19.5% Probability 30% Chance 40% Chance 30% Chance Return 20% 4% Return 30% 10% 20% Project 3 Standard Deviation 15% Probability 10% Chance 40% Chance 40% Chance 10% Chance Return 30% 15% 10% 21% If you are a risk-averse investor, which one should you choose? A) Project A C) Project C B) Project B D) None of the above

Explanation / Answer

20) Project 1 Probablity Return Expected return 50% 20% 10.0% 50% -4% -2.0% Total 8.0% Sharpe ratio = Expected return / Standard deviation =8/12 =0.67 Project 2 Probablity Return Expected return 30% 30% 9% 40% 10% 4% 30% -20% -6% Total 7.0% Sharpe ratio = Expected return / Standard deviation =7/19.5 =0.36 Project 3 Probablity Return Expected return 10% 30% 3% 40% 15% 6% 40% 10% 4% 10% -21% -2% Total 10.9% Sharpe ratio = Expected return / Standard deviation =10.9/15 =0.73 Sharpe ratio gived us the return per unit of risk. Hence a risk averse investor will choose the project with the highest sharpe ratio i.e Project 3 Please hit the like button if the answer helped you else leave a comment for further clarification. Thank you! All the best!

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