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CFA Level 1 Question of the Week – Quantitative Methods

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    • Avatar of Matt_AnalystPrepMatt_AnalystPrep
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        14 Oct 2019 at 7:58 pm
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        An investor consults an investment manager to advise him regarding a certain type of the portfolios which would give him at least a 7% return on his investment (threshold return). The investment manager presents three portfolios exhibited in the following table:

        Portfolio A Portfolio B Portfolio C
        Expected Return 19% 23% 36%
        Standard Deviation 14% 26% 39%

        Using the Safety-First ratio assumption, the portfolio that is the most suitable for the investor is:

        • A. Portfolio A.
        • B. Portfolio B.
        • C. Portfolio C.
      • Avatar of Matt_AnalystPrepMatt_AnalystPrep
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          19 Oct 2019 at 7:13 pm
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          The correct answer is A.

          As provided in the following table, the Safety-First ratio of Portfolio A is the highest so it has the lowest probability of the portfolio returns falling below the investor’s threshold level of 7%. 

          Portfolio A Portfolio B Portfolio C
          Expected Return 19% 23% 36%
          Standard Deviation 14%  26% 39%
          Safety First ratio (0.19-0.07)/0.14 = 0.8571;    (0.23-0.07)/0.26 = 0.6153;     (0.36-0.07)/0.39 = 0.7435
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