Chartered Market Technician (CMT) Practice Exam

Risk aversion in investors typically implies a preference for which type of portfolio?

1. A portfolio with lower returns and lower variance

2. A portfolio with higher returns but higher variance

3. A portfolio with higher returns but lower variance

4. A portfolio with consistent but minimal returns

The correct answer is: A portfolio with higher returns but lower variance

The preference for a portfolio that features higher returns but lower variance directly aligns with risk aversion behavior in investors. Risk-averse investors typically seek to maximize their returns while simultaneously minimizing the volatility or risk associated with their investments. A portfolio with higher returns coupled with lower variance indicates a more favorable risk-return trade-off, as it not only offers the potential for better returns but also maintains a manageable level of risk. This preference demonstrates the investor's desire to achieve gains without exposing themselves to significant price fluctuations. While seeking higher returns is a characteristic of many investors, those who are risk-averse specifically prioritize stability and protection against substantial losses. Thus, a portfolio characterized by higher returns and lower variance is viewed as optimal for someone with risk aversion, as it aims to secure gains while minimizing the potential downsides typically associated with more volatile investments.