George wants to pick a stock for his Diversified Hedge Fund.The fund has holdings in every country with a stock market.George is trying to decide which asset he should add to his portfolio: Stock A or Stock B.Expected return,Standard deviation and beta values for the two stocks are outlined in the table below.Which stock is best for George's portfolio and why?

Question

Quizplus · Accepted Answer

Since George's portfolio is diversified, he is only concerned with systematic (non-diversifiable) risk. Recall that Beta measures the amount of systematic risk possessed by an asset. Beta is the relevant measure of risk for George, and he should choose the stock with the highest return premium per unit of beta risk (Treynor index).
Recall that the Treynor Index measures the excess of an asset's return over the risk-free return per unit of systematic risk. George should choose the stock with the highest Treynor index.
Treynor Index = 11ea7fdb_fc0b_0f11_a768_fb66ee8022e9_TB2902_11 Treynor Index for Stock A = 11ea7fdb_fc0b_3622_a768_a93009ef310d_TB2902_11 = 0.03
Treynor Index for Stock B = 11ea7fdb_fc0b_3623_a768_57cbba02e9aa_TB2902_11 = 0.035
Since Stock B has a greater Treynor index, it offers a higher reward per unit of risk. George should choose Stock B.

George Wants to Pick a Stock for His Diversified Hedge