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There are two mutually exclusive investment opportunities
There are two mutually exclusive investment opportunities. Their returns are independent and normally distributed. First alternative has an expected return of 10.4% and standard deviation of 1.2%. Second alternative has an expected return of 11% and standard deviation of 4%. If an investor wants to earn at least 10% return, which one should she choose? (Hint: Which one offers higher probability of earning 10% return?)
Expert Solution
It is easily reflected that the standard deviation of first project has been very low in comparison to the second project and both are almost talking with a similar rate of return so it can be seen that the investor rate of return is 10%, and both the projects are providing him with the higher rate of return than 10%, and he will be choosing the project which is offering with lower standard deviation.
Standard deviation are reflective of the overall risk associated with the investment and it will be reflecting the higher degree of volatility so it will be always preferred by the company with lower degree and hence second alternative will be selected by the investor company because it is providing it with higher rate of return and it is also exposed to lower risk.
INVESTOR COMPANY WILL BE SELECTING SECOND ALTERNATIVE.
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