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

Question

Quizplus · Accepted Answer

The investor is highly risk-averse, meaning they are primarily concerned with minimizing risk. Both potential stocks have the same expected return and correlation with the market. However, stock B has a lower standard deviation of returns, indicating less overall risk. Therefore, the investor should add Stock B to their portfolio to minimize their overall risk.

Highly Risk-Averse Investor Is Considering Adding One Additional Stock to a 3-Stock