A T-bill pays 6 percent rate of return.Would risk-averse investors invest in a risky portfolio that pays 12 percent with a probability of 40 percent or 2 percent with a probability of 60 percent?
A) Yes,because they are rewarded with a risk premium.
B) No,because they are not rewarded with a risk premium.
C) No,because the risk premium is small.
D) Cannot be determined.
E) None of these.

Question

Quizplus · Accepted Answer

Risk-averse investors would not invest in a risky portfolio that pays 12 percent with a probability of 40 percent or 2 percent with a probability of 60 percent because the risk premium is not sufficient to compensate for the higher risk. The risk premium is calculated as the difference between the expected return of the risky portfolio and the risk-free rate, which in this case would be 0.4(12%) + 0.6(2%) - 6% = -1.2%. As a result, investors would be better off investing in the risk-free T-bill.

A T-Bill Pays 6 Percent Rate of Return