Investment Process

Which is not an implication of risk aversion for the investment process? A. The capital market line (CML) is upward sloping. B. The security Market line (SML) is upward sloping. C. The Promised yield on AAA bonds is higher than on A bonds. D. A positive relationship exists between expected return and expected risk


C The Yield on AAA bonds should be lower than the yield on A bonds for a rational investor.

C is the answer. A handy rule for remembering bond ratings is that more letters are better than fewer (assuming the letters are the same). So the A bond is risker than the AAA bond but is also offering a lower yield. Rather than being compensated for taking on the additional risk in moving from AAA to A, investors are being penalized with a lower yield. That indicates an affinity for risk, not an aversion for risk.