Characterize the investment objective given below as one of the following: an absolute risk objective, a relative risk objective, an absolute return objective, or a relative return objective.
Limit the standard deviation of portfolio returns to 20 percent a year or less.
Absolute vs. Relative Investment Objectives:
This question requires a general understanding of risk vs. return and absolute vs. relative performance objectives. An investment return is simply the increase or decrease in the total value (earnings and price change) of an investment over some period of time. Risk, on the other hand, is the volatility associated with the investment's value. An absolute performance objective is defined with a focus solely on the investment of interest, whereas a relative performance objective is defined in relation to a comparable investment or benchmark.
Answer and Explanation:
The following objective is an absolute risk objective: "Limit the standard deviation of portfolio returns to 20 percent a year or less." I say this, because we are clearly dealing with risk/volatility (standard deviation of portfolio returns), rather than return. Moreover, the objective is absolute, because it stands on its own. The objective has not specified the risk limit in relation to any external benchmarks or composites.
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from Finance 305: Risk ManagementChapter 3 / Lesson 3