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CFA Level I · CFA Level I Exam · The Return and Risk of a Financial Portfolio

An investor's indifference curve is plotted in expected return (vertical axis) versus standard deviation (horizontal axis) space. For a more risk-averse investor compared with a less risk-averse investor, the indifference curve is most likely:

The more risk-averse investor's indifference curve is steeper. Such an investor requires a larger increase in expected return to compensate for each additional unit of standard deviation, while a less risk-averse investor needs less compensation and has a flatter curve.

  1. Aflatter, because less extra return is needed per unit of risk.
  2. Bsteeper, because more extra return is needed per unit of risk.Correct
  3. Cvertical, because return is irrelevant to utility.

Explanation

Greater risk aversion means the investor demands a larger increase in expected return for each additional unit of risk to stay equally satisfied, so the curve is steeper. A flatter curve describes lower risk aversion.

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