Your Friend Is Considering Adding One Additional Stock to a 3-Stock

Multiple Choice

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. 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. Which stock should this investor add to his or her portfolio, or does the choice not matterσ

A) stock a.
B) stock b.
C) neither a nor b, as neither has a return sufficient to compensate for risk.
D) add a, since its beta must be lower.
E) either a or b, i.e., the investor should be indifferent between the two.