Consider the following investments. Expected return Standard deviation Portfolio

Question

Consider the following investments.

Expected return Standard deviation

Portfolio A 10% 5%

Portfolio B 14% 4%

Portfolio C 17% 8%

Required: (1). If L R (the level of return which your portfolio would not be below) equals 5%, which is your preferred portfolio for your investment according to Roy’s safety-first criterion? Assume returns are continuously distributed

(2). If the Kataoka probability equals 5%, which is your preferred portfolio for your investment according to Kataoka’s safety-first criterion?

Explanation / Answer

1)

Based on our calculations, using Roy’s safety-first criterion you should pick the portfolio B, which is less likely to fall below the return threshold

SF ratio(A) (10-5)/5 1.00 SF ratio(B) (14-5)/4 2.25 SF ratio(C) (17-5)/8 1.5

Based on our calculations, using Roy’s safety-first criterion you should pick the portfolio B, which is less likely to fall below the return threshold

2) Maximise A) 10 0.00 B) 14 -1.00 C) 17 3.00 based on our calculation to maximise the return based on kataoka safety first criterion you should pick the portfolio C with 17% return.

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