Assume there are twoinvestments to choose from: investment A has an expected return of 10% and astandard deviation of 15%, and investment B also has an expected return of 10%but its standard deviation is 20%. The risk neutral investor would:
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| A) | choose investment A because it has a higher return for a given level of risk. |
| B) | choose either investment A or B since they are not concerned about the level of risk but only with the level of return. |
| C) | not choose investment B because it has a higher level of risk with no additional compensation |
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solution:B
Given two alternatives with the same expected return but different levels of risk (i.e., different standard deviations), the risk-neutral investor would be indifferent between the two alternatives, the risk-averse investor will select the alternative with less risk, and a risk-seeking investor would actually prefer (derive more utility from) the riskier alternative.
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