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Which of the alternatives would choose

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You're a financial analyst that evaluates stocks and then forms portfolios for clients. You found a stock that has a beta of 1.3 and an expected return of 13%.

You also have the following data:

Risk Premium on the Market Portfolio 7%

Standard Deviation of Market Portfolio 30%

Risk-Free Fate 5%

Standard Deviation of the Return on this Stock 70%

You are certain all your data is correct.

Consider the following alternatives:

A. Set the weight on this stock to some non-trivial positive value in which case portfolio returns will be affected by some of this stock's firm-specific risk.

B. Set the weight on this stock to its weight in the market portfolio so that portfolio returns are not affected by any of this stock's firm-specific risk.

C. Set the weight on this stock to a nontrivial negative value (short-sell the stock) even though this means that some of the stock's firm-specific risk will affect portfolio returns.

Problem 1: Which of the above alternatives would you choose?

Reference no: EM132969415

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