Chapter 20, Problem 10P

To determine

To determine: The portfolio that would be preferred by risk- neutral investors and if a risk-neutral investor will ever choose LifeStrategy Conservative Growth.

Concept introduction

Expected Value: It is defined as the weighted average of probable events where the weights of each probable value corresponds to the chances of that value occurring. The formula to calculate the expected value is:

Where,

• is expected value.
  
• is probability of event 1.
  
• is probability of event 2.
  
• is probability of event N.
  
• is event 1.
  
• is event 2.
  
• is event N.
  

Expected Utility: It is defined as the value of a person’s total utility, so that there is no certainty about future results.

Risk Averse: When a person does not like taking risk, then he is referred to as risk averse. In case of risk averse, the marginal utility is diminishing in nature which means that for every additional unit of good, the marginal utility declines.

Risk Neutral: When a person does not care for risk it means that he is insensitive to any kind of risk, and is referred to as risk neutral.