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

Question

Quizplus · Accepted Answer

Given the investor's high risk aversion, they should prefer Stock B because it has a lower standard deviation of returns (8%) compared to Stock A (12%), indicating lower risk for the same expected return of 15%. Both stocks have the same correlation with the market, so the lower risk of Stock B makes it the preferable choice for a risk-averse investor.

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