You are a risk-averse investor who is considering investing in one of two econom
ID: 2784047 • Letter: Y
Question
You are a risk-averse investor who is considering investing in one of two economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move togethern good times all prices rise together, and in bad times they all fall together. In the second economy, stock returns are independent-one stock increasing in price has no effect on the prices of other stocks. Which economy would you choose to invest in? Explain. (Select the best choice below.) O A. A risk averse investor would choose the economy in which stocks move together because the uncertainty is much more predictable, and you have to predict only one thing. ( B. A risk averse investor is indifferent in both cases because he or she faces unpredictable risk. C. A nsk averse investor would choose the economy in which stock returns are independent because risk can be diversified away in a large portfolio. O D. A risk averse investor would prefer the economy in which stock returns are independent because by combining the stocks into a portfolio he or she can get a the economy in whinbeby combining the higher expected return than in the economy in which all stocks move together.Explanation / Answer
C. A risk averse investor would choose the economy in which returns are independent because risk can be diversified away in a large portfolio.
Given , that we are risk averse.
Which means that every possibility to reduce the risk is given priority , rather than the possibility ot maximmise the return.
Investing in a economy in which all stocks move in tandem is a risk, since any adversity in the economy will reduce the value of whole portfolio.
Whereas, investing in the economy with independent stocks,will see that any fall in the value of a stock will be off set by an increase in other stock,therby mitigating certain amount of risk.
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