You must add one of two investments to an already well- diversified portfolio .

Question

You must add one of two investments to an already well- diversified portfolio.

Security A                               Security B

Expected Return = 14%          Expected Return = 12%

Standard Deviation of             Standard Deviation of

Returns = 15.0%                     Returns = 11%

Beta = 1.5                               Beta = 1.5

If you are a risk-averse investor, which one is the better choice?

A) Security A

B) Security B

C) Either security would be acceptable.

D) Cannot be determined with information given.

Explanation / Answer

The investor is a risk averse that means he would prefer a lower return for a known risk rather than a higer return for an unknown risk. Thus in this case since the Beta for both the security is same . and Beta is the measure of the systematic risk. The investor would prefer Security A, since with the similar risk security A is offering higher expected return.

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