Suppose your client is risk-averse but can invest in only one of the three secur

Question

Suppose your client is risk-averse but can invest in only one of the three securities, A, B, or C, in an uncertain world characterized as follows. Next year the economy will be in an expansion, normal, or recession state with probabilities 0.43, 0.31, and 0.26, respectively. The returns (%) on the securitiies in these states are as follows: Security A {expansion = +16.75, normal = +11.00, recession = +6.00}; Security B {+14.00, +7.50, +4.50}; Security C {+13.00, +11.00, +6.50}. Which security can you rule out, that is, you will not advise your client to invest in it?

Explanation / Answer

average return from A= 0.43*16.75+0.31*11+0.26*6=7.2025+ 3.41+1.56= 12.1725%

B= 0.43*14+ 0.31*7.5+0.26*4.5= 6.02+ 2.325+1.17= 9.515

C= 0.43*13+0.31*11+0.26*6.5= 5.59+3.41+1.69= 10.69

security B is not advised to invest.

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