Highly Risk-Averse Investor Is Considering Adding One Additional Stock to a 3-Stock

question 134

Multiple Choice

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 they are perfectly positively correlated with the market.Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and 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 not matter?

• A)Either A or B, i.e., the investor should be indifferent between the two.
• B)Stock A.
• C)Stock B.
• D)Neither A nor B, as neither has a return sufficient to compensate for risk.
• E)Add A, since its beta must be lower.

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