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:

Capital Stock

Total assets held by a firm, including buildings, machinery, equipment, and patents, used to produce goods and services.

Depreciation

The process through which the value of an asset decreases over time, often used to spread the cost of a tangible asset over its useful life.

Gross Investment

The total amount invested in the creation of new capital assets like buildings and machinery before accounting for depreciation.

Disposable Income

is the amount of money that households have available for spending and saving after income taxes have been accounted for.