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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.
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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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