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Stocks, Returns and Standard deviation

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The table below shows information about the performance of stocks A and B last year.

Return Standard Deviation
Stock A 15% 8.3%
Stock B 14% 2.1%

1. As a financial advisor, are there factors other than return and risk that should be considered in making this decision?
2. Based on these factors, what stock would you recommend to the client?
3. What reasons will you convey to your client to justify your decision in recommending this stock?
4. How will this recommendation impact the client?

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Solution Summary

Answered in over 600 words. Reasons are given for the answers and choices made.

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1. When considering investments in stocks such as Stock A and Stock B, there are indeed factors beyond return and risk (standard deviation in this case) that should be considered. These factors include the following:

Risk Tolerance: This is about how comfortable the client is with the potential fluctuations in the value of her investment. Some clients are more risk-averse and are less able to withstand frequent ups and downs in the stock price; this should be taken into account when investing. A stock with a lower standard deviation represents less fluctuation in stock price and may be more suitable for risk-averse clients.

Diversification: How does the investment fit with the client's existing portfolio? It's important to ensure that the new investment complements and diversifies the current holdings to spread risk. If Stock A and Stock B are in two different industries (for example if one stock is in the education industry while the other is in the healthcare industry), purchasing both stocks can create a portfolio that is better able to ...

Solution provided by:
  • MSc, California State Polytechnic University, Pomona
  • MBA, University of California, Riverside
  • BSc, California State Polytechnic University, Pomona
  • BSc, California State Polytechnic University, Pomona
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