Your Friend Is Considering Adding One Additional Stock to a 3-Stock

question 141

Multiple Choice

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.She is highly risk averse and has asked for your advice.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) Stock A.
• B) Stock B.
• C) Neither A nor B, as neither has a return sufficient to compensate for risk.
• D) Add A, since its beta must be lower.
• E) Either A or B, i.e., the investor should be indifferent between the two.

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Definitions:

Personal Mentoring

A developmental relationship where a more experienced or knowledgeable individual provides guidance and support to a less experienced or knowledgeable person.

Management Control

The process of monitoring and adjusting an organization's activities and operations to meet pre-defined objectives and ensure optimal performance.

Goal Motivate Performance

The concept that setting objectives can inspire and improve an individual's or group's work output or effectiveness.

Fostering Action Plans

Developing and implementing strategies to achieve specific goals, often involving the coordination of resources and tasks.