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

Kayla Oehler · Accepted Answer

Final Answer : C, Explanation :  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.

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