The distributions of rates of return for Companies AA and BB are given below: $\begin{array}{llrr}
\text { State of the}& \text {Probability of }\
\underline{\text { Economy }} & \underline{ \text { This State Occurring }} & \underline{\text { A.A }} & \underline{\text { BB }} \
\text { Boom } & 0.2 & 30 \% & -10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & -5 \% & 50 \%
\end{array}$

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Question

The distributions of rates of return for Companies AA and BB are given below: $\begin{array}{llrr}
\text { State of the}& \text {Probability of }\
 \underline{\text { Economy }} & \underline{ \text { This State Occurring }} & \underline{\text { A.A }} & \underline{\text { BB }} \
\text { Boom } & 0.2 & 30 \% & -10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & -5 \% & 50 \%
\end{array}$
 
We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Quizplus · Accepted Answer

A rational, risk-averse investor would consider both the expected return and the risk (volatility) of the securities. Security BB has a higher expected return due to its high return in recession, which may appeal to risk-averse investors seeking diversification benefits.

The Distributions of Rates of Return for Companies AA and BB