Question

You have research the following three stocks, Stock A : STD 20%, B =1.1; Stock B : STD 30%, B =0.9; Stock C : STD 15%, B = 1.

If you wanted to reduce the risk you held in isolation you would choose stock .

If you wanted to reduce the risk you held as part of a diversified portfolio, you would hold stock .

Answer 1

If you wanted to reduce the risk you held in isolation you would choose stock C, because it's has a Beta = 1, it means risk in the stock is only systematic risk as beta of market is also equal to 1.

If you wanted to reduce the risk you held as part of a diversified portfolio, you would hold stock A and stock B, because stock A has a Beta of 1.1 and stock B has a Beta of 0.9 it means the correlation coefficient between stock A and B would be less than 1 hence the risk of the portfolio is less than total risk of individual stock A and B, it's known as diversification benefit.