You have been scouring The Wall Street Journal looking for stocks to add to your (large) portfolio.The table presents data that you have collected on four stocks that look promising.You have calculated the return that you anticipate earning from each stock along with its beta.Which of the four securities should you add to your portfolio? (Assume you must choose just one.) Assume the risk-free rate is 7.00% and the market risk premium is 2.00%.

Question

Quizplus · Accepted Answer

Calculate the Treynor Index (TI) of each stock, and compare each to the market's Treynor Index (slope of Security Market Line):
Treynor Index = 11ea7fdb_fc0b_5d35_a768_ab7b1250ed95_TB2902_11 Treynor Index for the market = 11ea7fdb_fc0b_5d36_a768_9127d9553ba4_TB2902_11 = 0.02
Treynor Index for Stock A = 11ea7fdb_fc0b_5d37_a768_db2f4250b0f8_TB2902_11 = 0.01182
Treynor Index for Stock C = 11ea7fdb_fc0b_5d38_a768_959299c98278_TB2902_11 = 0.02
Treynor Index for Stock D = 11ea7fdb_fc0b_5d39_a768_1b6578dd13d0_TB2902_11 = 0.018
We can see that Stock C plots on the SML, while Stocks A and D plot below it. Without calculating the Treynor Index of Stock B, we know that it plots above the SML. This is because it has a Beta equal to zero (i.e. risk free) and it has a rate of return (7.06%) higher than the risk free rate (7%).

You Have Been Scouring the Wall Street Journal Looking for Stocks