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

question 82

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 matterσ

• 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:

Coalition

An alliance between individuals, groups, or nations, formed temporarily to achieve a specific goal, often combining resources for greater influence or power.

Stalemate

A situation, often in a game of chess, where no move can lead to a checkmate, resulting in a draw; metaphorically, any situation where progress is impossible.

Alliance

A formal agreement or partnership between individuals, businesses, or countries to pursue shared goals or to meet common objectives.

Forgive Remember

The process of choosing to forgive someone while still remembering the incident to learn from it without holding a grudge.