A Highly Risk-Averse Investor Is Considering Adding One Additional Stock

question 146

Multiple Choice

A highly risk-averse investor is considering adding one additional stock to a three-stock portfolio,to form a four-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?

• A)either A or B, i.e., the investor should be indifferent as to which of the two
• B)Stock A
• C)Stock B
• D)neither A nor B, as neither has a return sufficient to compensate for risk

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Definitions:

Volcanic Mudflows

Also known as lahars, these are rapid flows of debris, mud, and water that descend from a volcano, typically following an eruption or heavy rainfall.

Flow-Banded Rhyolite

A type of volcanic rock characterized by bands of alternating texture or color, formed by the flow of viscous silicate lava.

Viscous Lava

Lava that has a high viscosity, meaning it flows slowly due to its thick, sticky consistency.

Lateral Blast

A volcanic eruption characterized by the powerful, horizontal expulsion of ash, gas, and volcanic debris, often occurring with little to no warning.