A highly risk-averse investor is considering adding one additional stock to a 3-

Question

1. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market.Potential new Stocks A and B both have expected returns of 15%, and both are equally correlated with the market, with r = 0.75.However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio, or does the choice matter? Answer A. Stock A. B. Stock B. C. Either A or B, i.e., the investor should be indifferent between the two. D. Add A, since its beta must be lower. E. Neither A nor B, as neither has a return sufficient to compensate for risk.
   

1. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market.Potential new Stocks A and B both have expected returns of 15%, and both are equally correlated with the market, with r = 0.75.However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio, or does the choice matter? Answer A. Stock A. B. Stock B. C. Either A or B, i.e., the investor should be indifferent between the two. D. Add A, since its beta must be lower. E. Neither A nor B, as neither has a return sufficient to compensate for risk.
   

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market.Potential new Stocks A and B both have expected returns of 15%, and both are equally correlated with the market, with r = 0.75.However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio, or does the choice matter? Answer A. Stock A. B. Stock B. C. Either A or B, i.e., the investor should be indifferent between the two. D. Add A, since its beta must be lower. E. Neither A nor B, as neither has a return sufficient to compensate for risk.
A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market.Potential new Stocks A and B both have expected returns of 15%, and both are equally correlated with the market, with r = 0.75.However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio, or does the choice matter? Stock A. Stock A. Stock B. Stock B. Either A or B, i.e., the investor should be indifferent between the two. Either A or B, i.e., the investor should be indifferent between the two. Add A, since its beta must be lower. Add A, since its beta must be lower. Neither A nor B, as neither has a return sufficient to compensate for risk. Neither A nor B, as neither has a return sufficient to compensate for risk. A. Stock A. B. Stock B. C. Either A or B, i.e., the investor should be indifferent between the two. D. Add A, since its beta must be lower. E. Neither A nor B, as neither has a return sufficient to compensate for risk.

Explanation / Answer

The correct choice is c) Stock B. This is because the two stocks are equally correlated with the market, both have the same expected returns, the only difference is that Stock A has a higher standard deviation. And since the investor is risk averse, then he would prefer a stock that does not have a high standard deviation

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