Your sister is considering to add one additional stock to a three stock portfoli

Question

Your sister is considering to add 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 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=0.75. However, stock A's standard deviation of returns is 12% versus 8% for stock B. Why should i add additional stock to my sister's portfolio?

Explanation / Answer

Answer:

Stock-B should be added to her portfolio as stock-B has less risk than Stock at the same 15% return on both the stocks.

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