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 1

Answer: B; A

Explanation:

A strict risk minimizer would work to avoid risk at all costs. For this reason they will pick Stock B if it were held in isolation. This is because it has the lowest Standard Deviation which is a measure of risk. As the deviation is the lowest, it is the least risky.

If the stock is to be held in a well diversified Portfolio then Stock A will be picked. Standard Deviation has Unsystematic risk which is diversified away in a well diversified portfolio therefore the measure of risk here is the beta. The lowest beta is the least riskiest and so the strict risk minimizer will pick Stock A.