Question

Which stock, A or B, or both of them, is preferable to add to the diversified portfolio, and why? if the information about each stock as follows:

stock A: Average annual return-117.4, Average return 11.7%, Standard deviation 8.9, Coefficient of variation 0.8, Required return 11.8, beta 1.6

stock B: Average annual return-111.4, Average return 11.1%, Standard deviation 2.7, Coefficient of variation 0.2, Required return 10.3, beta 1.1

Risk free rate 7%

Market return 10%

Covariance 11.95

Correlation coefficient 0.48

Return on a portfolio (with both stocks A and B) 11.44

Standard deviation of a portfolio 5.26

Answer 1

Answer

From the information which are provided, it will be better to opt for both of them instead of just going for option A or B individually. Potential investors in the business always try to have a diversified investment strategy which is needed to neutralize the associated risk with such kind of investment made in the market. The standard deviation is satisfactory in case of making a diversified investment in both the projects which are associated with the business. The reason behind going for a diversified investment strategy is that only investing in option A is quite an aggressive strategy with a potentially high amount of risk. To avoid risk, opting for B will not be a great option as the return generated from B is quite low with the minimum risk associated with it. In that case it quite important for the business to go for both the option in a diversified manner to have a great investment strategy.