distributions of rates of return for Companies AA and BB are given below:
$$\begin{array} { l c c c }
{ \begin{array} { c }
\text { State of the } \
\text { Economy }
\end{array} } & \begin{array} { c }
\text { Probability of This } \
\text { State Occurring }
\end{array} & \text { AA } & \text { BB } \
\text { Boom } & 0.2 & 30 \% & - 10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & - 5 \% & 50 \%
\end{array}$$

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Question

distributions of rates of return for Companies AA and BB are given below:
$$\begin{array} { l c c c } 
{ \begin{array} { c } 
\text { State of the } \
\text { Economy }
\end{array} } & \begin{array} { c } 
\text { Probability of This } \
\text { State Occurring }
\end{array} & \text { AA } & \text { BB } \
\text { Boom } & 0.2 & 30 \% & - 10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & - 5 \% & 50 \%
\end{array}$$

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Quizplus · Accepted Answer

A rational, risk-averse investor would consider both the expected return and the risk (volatility) of the securities. Security BB has a high return in a recession, which might provide better diversification benefits and risk reduction in a well-diversified portfolio, despite its lower expected return compared to Security AA.

Distributions of Rates of Return for Companies AA and BB