P8–3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z. Sharon will evaluate each of these investments to decide whether they are superior to investments that her company already has in place, which have an expected return of 12% and a standard deviation of 6%. The expected returns and standard deviations of the investments are as follows:

a. If Sharon were risk neutral, which investments would she select? Explain why.

b. If she were risk averse, which investments would she select? Why?

c. If she were risk seeking, which investments would she select? Why?

d. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?

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Investment Expected Standard return deviation XY 14% 7% 12 8 Z 10 9