FIN 534 - Homework Chapter 6

1. You are considering investing in one of the these three stocks:

Stock

Standard Deviation

Beta

A

20%

B

10%

C

12%

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. 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 . 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. Stock A.

b. Stock B.

c....