Consider the following two stocks. The risk-free rate is 4% and the average stock’s risk premium is 8%.
Stock A Stock B
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Beta 1.2 0.7
Standard deviation 11% 15%
a) When you hold a well-diversified portfolio, what stock should you choose to reduce the risk? You should explain.
b) If you construct a portfolio that consists of Stock A and Stock B (only two stocks), find the required rate of return on your portfolio.
c) If the expected return on Stock A is 12%, is it good to invest in this stock? You should show your work and explain.