Answer: 1.9%.

The target downside deviation is calculated using the formula: \[ \text{Target Downside Deviation} = \sqrt{\frac{\sum (X_i - B)^2 \cdot I(X_i \leq B)}{n - 1}} \] where: - \( X_i \) is the return for each period, - \( B \) is the target return (5%), - \( n \) is the total number of observations (5), - \( I(X_i \leq B) \) is an indicator function that includes only returns less than or equal to the target. **Steps:** 1. Identify returns below the target (3%, 2%, 4%). 2. Calculate squared deviations for these returns: \((3-5)^2 = 4\), \((2-5)^2 = 9\), \((4-5)^2 = 1\). 3. Sum the squared deviations: \(4 + 9 + 1 = 14\). 4. Divide by \(n - 1 = 4\): \(14 / 4 = 3.5\). 5. Take the square root: \(\sqrt{3.5} \approx 1.87% \), rounded to 1.9%. **Why not A or C?** - **A** incorrectly uses \(n = 5\) instead of \(n - 1\). - **C** includes all returns, not just those below the target, leading to an overestimation.

Author: LeetQuiz Editorial Team