You are going to add one of the following three projects to your already well-diversified portfolio
PROJECT 1 PROJECT 2
Probability Return
Standard
Deviation Beta Probability Return
Standard
Deviation Beta
50% Chance 22% 12% 1.1 30% Chance 36% 19.5% 0.8
50% Chance -4% 40% Chance 10.5%
30% Chance -20%
PROJECT 3
Probability Return
Standard
Deviation Beta
10% Chance 28% 12% 2.0
70% Chance 18%
20% Chance -8%
Assume the risk-free rate of return is 2% and the market risk premium is 8%. If you are a risk
averse investor, which project should you choose?
A) Project 1
B) Project 2
C) Project 3
D) Either Project 2 or Project 3 because the higher expected return on project 3 offsets its higher
risk
B
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