Question

Stock A has more systematic risk than stock B, stock B has more unsystematic risk than stock A, and it is unclear which stock (A or B) has more total risk. Both stock A and stock B have more systematic risk than the market. Which of the following assertions is most consistent with finance theory regarding risk and diversification?

Answer 1

As we know that unsystematic risk can be eliminated or reduced by diversification and therefore this risk is not rewarded .While systematic risk is the market related risk which cannot be reduced or eliminated and therefore compensation for systematic risk is provided in expected return .

Therefore we can say,As per finance theory regarding risk and diversification,

As Stock A has higher systematic risk than stock B and market both .Hence,

Stock A would have higher expected return than stock B

Also,Stock A would have higher expected return than market.

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