OT: Finance HW Problem

[RU23]

I've asked advice for my son in the financial industry a few times on this board and got great responses so I immediately thought of you guys when he approached me with a hw problem. I'm not a finance guy so I'm usually not much help. Here's the question:

Suppose that, over the month of November 2013, people for some reason unexpectedly become more risk-averse. Should the expected (or required) rate of return on risky assets be higher or lower at the end of November than at the beginning? Is the realized rate of return on risky assets likely to be high or low over the month of November?

I don't think the question is worded well at all, but I could be wrong. Now we both decided the realized return would be lower as lower risk means less average return, but the expected return part has us confused. Any help would be appreciated!

 

[bethlehemfan]

Higher and lower

 

[RU23]

Higher and lower

Thanks, that was our guess. Could you give a quick explanation?

 

[bethlehemfan]

If you are more risk averse you want a higher return for your investment. If you had a risky asset in the beginning of November and people became more risk averse the value of your risky assets would decline.

 

[RU23]

If you are more risk averse you want a higher return for your investment. If you had a risky asset in the beginning of November and people became more risk averse the value of your risky assets would decline.

So from what I've learned expected return is the "likely average" return. I'm just not quite understanding why that average goes up as people become more risk averse.

 

[bethlehemfan]

The price of th asset goes down but the return you demand goes up. In other words if you are risk averse you will want a higher return to buy that risky asset.

 

[RU23]

The price of th asset goes down but the return you demand goes up. In other words if you are risk averse you will want a higher return to buy that risky asset.

Thank you!

 

[knight90]

I've asked advice for my son in the financial industry a few times on this board and got great responses so I immediately thought of you guys when he approached me with a hw problem. I'm not a finance guy so I'm usually not much help. Here's the question:

Suppose that, over the month of November 2013, people for some reason unexpectedly become more risk-averse. Should the expected (or required) rate of return on risky assets be higher or lower at the end of November than at the beginning? Is the realized rate of return on risky assets likely to be high or low over the month of November?

I don't think the question is worded well at all, but I could be wrong. Now we both decided the realized return would be lower as lower risk means less average return, but the expected return part has us confused. Any help would be appreciated!

Required return will rise as investors become more risk averse.. Simple reason is if your level of risk aversion rises then the return that you demand will rise to compensate for the risk you take.. Realized rate of return of return on risky assets (if you realize your pnl) would likely be lower because as investors become more risk averse they shift from risky assets like equities to safer assets like fixed income assets and risky asset values fall.

 

[RU23]

Required return will rise as investors become more risk averse.. Simple reason is if your level of risk aversion rises then the return that you demand will rise to compensate for the risk you take.. Realized rate of return of return on risky assets (if you realize your pnl) would likely be lower because as investors become more risk averse they shift from risky assets like equities to safer assets like fixed income assets and risky asset values fall.

Thank you! Makes sense now