As a financial advisor, you are assigned a new client who is considering investi

Question

As a financial advisor, you are assigned a new client who is considering investing in one of two stocks, A or B.

The table below shows information about the performance of stocks A and B last year.

As a financial advisor, are there factors other than return and risk that should be considered in making this decision?

Based on these factors, what stock would you recommend to the client?

What reasons will you convey to your client to justify your decision in recommending this stock?

How will this recommendation impact the client?

Explanation / Answer

Apart from risk and return they need to analyze several other factors. Like what is the current state of economy and which stock performs well in this state. What is the investment horizon of the investor? Are Investors going to hold the stock for long period of time or short period of time? The investor is risk seeker or risk averse. If investor is risk seeker, he won’t mind taking an extra risk for an additional return and if the investor is risk averse, he will not take risk.

I would recommend the investor should choose the stock based on its coefficient of variation.

Coefficient of variation = Standard Deviation/ Return

                Stock A = 8.3%/15%

                                =0.5533

                Stock B = 2.1%/14%

                                =0.15

Stock B has lower coefficient of variation that means for each additional unit of return, the investor has to take less risk with stock B. Therefore, Stock B is recommended.

The recommendation is based on risk / reward ratio. Everyone wants to maximize the return by taking least possible risk. Stock B is in line with the objectives of a general investor.

Since I am taking a rational view on risk and return, this recommendation will help the investor to take a rational view on their future investments.

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