You have the following data on three stocks: Stock Standard Deviation Beta A 20%
ID: 2664010 • Letter: Y
Question
You have the following data on three stocks:Stock Standard Deviation Beta
A 20% 0.59
B 10% 0.61
C 12% 1.29
If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.
Answer
A) A; A.
B) A; B.
C) B; A.
D) C; A.
E) C; B.
Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?
Answer
A) Variance; correlation coefficient.
B) Standard deviation; correlation coefficient.
C) Beta; variance.
D) Coefficient of variation; beta.
E) Beta; beta
Explanation / Answer
Question 1: A risk minimizer would chose stock B in isolation because it has the lowest standard deviation (which is the measure of all risk the investor faces). As part of a well diversified portfolio a risk minimizer would chose stock A because it would add the lowest risk. A well diversified portfolio investor won't even consider standard deviation risk because it has irrelevant things built in (like unsystematic diversifiable risk). The correct answer is C.
Question 2: The correct answer is B. Standard deviation is the standard risk measure used to look at a security held in isolation. But you could actually make a very good case for A too. Most finance texts will tell you B is the right answer just because standard deviation is the "more common" measure of total risk. But variance is still an "acceptable" measure of risk it's just a bigger number and harder to compare securities with variance. Correlation coefficient is also right because an investor with a portfolio is always most concerned about how new securities are related to what they're already holding (correlation).
Hope this helps!
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