Answer to Question #178490 in Financial Math for Nourin

Question

Your eccentric uncle died and left you $100,000. However, the will stipulated that the entire amount must be invested in common stocks. Specifically, $50,000 must be invested in a single stock (a one-stock portfolio) and the other $50,000 must be invested in a 100-stock portfolio. You are very risk averse, so you want to minimize the riskiness of each $50,000 investment.

a. Describe the kind of stock you would choose for your single-stock portfolio?

b. What types of stock would you choose the stocks for your 100-stock portfolio?

c. From a practical standpoint, how should you view the riskiness of your single-stock portfolio?

Answer 1

a) The stock whose beta is lower as lower beta means lower market risk

b) I will choose that portfolio whose stocks have a correlation coefficient of 1 for lower risk

c) Single stock portfolio will always have more risk than 100 stock portfolio, due to diversifiable risk which is not there in a portfolio.