Question

S-13 Differentiate among the three basic risk preferences: risk-indifferent. risk-averse, and risk-seeking. Which of these attitudes toward risk best describes most investors?

S-14 Describe the steps involved in the investment decision process. Be sure to mention how returns and risks can be evaluated together to determine acceptable investments.

S-15 What is an efficient portfolio, and what role should such a portfolio play in investing?

S-16 How can the return and standard deviation of a portfolio be determined? Compare the calculation of a portfolio's standard deviation to that for a single asset.

Answer 1

S13 : A risk - indifferent investor is one who is indifferent between risk. He is neither a risk lover nor a risk averse investor.

Risk averse: investor is one who avoids risk, he looks for safe instruments for investment.

Risk seeking : this investor loves risk, and looks for opportunities where he can take more risk, as higher the risk, higher is the returns fro an investor.

Most investors are risk averse, they prefer safer investments as opposed to riskier ones.

S - 14: Investment decision is selecting a particular asset in which funds will be invested by an investor.

the steps involved are :

1. Determine the investment objectives

2. Developing investment plan

3. Evaluating and selecting among alternative investment opportunities.

4. Constructing a portfolio

5. Evaluating and making necessary revisions in the portfolio.

Before selecting a particular investment we should evaluate the return and risk . Safe investments have lower return and lower risk, a risky investments have higher risk and higher returns. Depending upon the risk preferences if the investor, a particular investment is chosen.

S -15: Efficient portfolios are portfolios which give the highest possible return for a given level of risk, or the one with a level of return for a lowest level of risk.

It helps in investing and determining the sub optimal assets , as portfolios below the efficient portfolio are sub optimal, as they do not provide enough return for a given level of risk. Portfolios to the right of the efficient frontier, are also not optimal as they provide lower return for a level of risk.This is how efficient portfolios help in investing decision making.

S-16: The return of a portfolio can be determined as :

suppose we have a two asset portfolio:'

Return is : weight of asset A* return of asset A + weight of asset B * return of asset B

Standard deviation of portfolio is :

root over of [[weight of asset A)^2 * (variance of A) + (weight of asset B)^2 * variance of B + 2 * (weight of A) * (weight of B )* (correlation of A and B ) ]

correlation of A and B = covariance of A and B/ standard deviation of A * standard deviation of B

Standard deviation of an asset measures the risk of an asset , whereas Portfolio standard deviation is the standard deviation of a portfolio of investments. It is a measure of total risk of the portfolio