SIDC Module 12 Portfolio theory question: ranks portfolios by U

Answer: A. E(r) 10% and standard deviation 15%

Utility rewards expected return and penalises variance: U = E(r) − 0.5 × 3 × σ², with returns in decimals. E(r) 10%, σ 15%: 0.10 − 1.5 × 0.0225 = 0.0663 (6.63%). E(r) 8%, σ 10%: 0.08 − 1.5 × 0.01 = 0.0650, a close second; the lowest-risk portfolio is not automatically best. E(r) 14%, σ 25%: 0.14 − 1.5 × 0.0625 = 0.0463. E(r) 18%, σ 35%: 0.18 − 1.5 × 0.1225 = −0.0038; the highest expected return carries a variance penalty larger than the return itself. Source: SIDC M12 Study Outline Topic 6.1 Risk Aversion and Utility; Bodie, Kane and Marcus, Investments, chapter 'Capital Allocation to Risky Assets' (U = E(r) − ½Aσ²); CFA Institute, Portfolio Risk and Return: Part I (2026 Level I) (as at October 2026).