Assume That Your Cousin Holds Just One Stock, Eastman Chemical

question 129

Multiple Choice

Assume that your cousin holds just one stock, Eastman Chemical Bonding (ECB) , which he thinks has very little risk.You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified.You obtain the following returns data for Wilder's Creations and Buildings (WCB) .Both companies have had less variability than most other stocks over the past 5 years.Measured by the standard deviation of returns, by how much would your cousin's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) $\begin{array}{rrr}&\text { Year }&\text { ECB }&W C B\\&2011 & 40.00 \% & 40.00 \% \\&2012 & -10.00 \% & 15.00 \% \\&2013 & 35.00 \% & -5.00 \% \\&2014 & -5.00 \% & -10.00 \% \\&2015 & 15.00 \% & 35.00 \%\\\text { Average return }= & 15.00 \% & 15.00 \% \\\text { Standard deviation }= & 22.64 \% & 22.64 \%\end{array}$

• A) 3.29%
• B) 3.46%
• C) 3.65%
• D) 3.84%
• E) 4.03%

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Definitions:

GAAP

Generally Accepted Accounting Principles, which are a collection of commonly-followed accounting rules and standards for financial reporting.

Research and Development

The investigative activities a business conducts to improve existing products and procedures or to lead to the development of new products and procedures.

Write-down

An accounting procedure reducing the book value of an asset when its market value drops below the recorded cost, resulting in a non-cash expense.

Impaired Asset

An asset that has a market value less than its carrying value on the balance sheet, indicating that it may not generate future benefits worth its listed value.