Question: A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market. Potential new Stocks A and B both have expected returns of 15%, and both 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 matter?
a. Either A or B, i.e., the investor should be indifferent between the two.
b. Stock A.
c. Stock B.
d. Neither A nor B, as neither has a return sufficient to compensate for risk.
e. Add A, since its beta must be lower.