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Risk Preference, Sensitivity Analysis, CAPM & SML

1.Compare the following risk preferences: (a) risk-averse, (b) risk-indifferent, and (c) risk-seeking. Which is most common among financial managers?

2.Explain how the range is used in sensitivity analysis.

3. Explain the meaning of each variable in the capital asset pricing model (CAPM) equation. What is the security market line (SML)?

Solution Preview

1. Risk averse preference is indicative of one who typically does not like risk. This type of person will likely accept an investment option with a lower return if the higher return option is riskier. A risk indifferent individual doesn't care either way regarding the higher risk of the same options as presented in the formal example. An investmnet option with a higher risk would be considered by this individual. A risk seeking individual is, as the name implies, is one who not only would consider a higher risk ...

Solution Summary

The solution compares risk preferences, the range used in sensitivity analysis, and explains the variables in the CAPM and describes the security market line in the SML.