The distributions of rates of return for Companies AA and BB are given below: $\begin{array}{c}
\begin{array}{l}
\text { State of the}\
\underline{\text { Economy}}\
\text { Boom}\
\text { Normal}\
\text { Recession}
\end{array}
\begin{array}{c}
\text { Probability of }\
\underline{\text {This State Occurring}}\
0.2 \
0.6 \
0.2
\end{array}
\begin{array}{l}
\
\underline{\text {A A}}\
3 0 \% \
10 \% \
-5 \%
\end{array}
\begin{array}{l}
\
\underline{\text {BB}}\
-10 \% \
5 \% \
50 \%
\end{array}
\end{array}$
We can conclude from the above information that any rational,risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Question

The distributions of rates of return for Companies AA and BB are given below: $\begin{array}{c}
\begin{array}{l}
\text { State of the}\
\underline{\text { Economy}}\
\text { Boom}\
\text { Normal}\
\text { Recession}
\end{array}
\begin{array}{c}
\text { Probability of }\
\underline{\text {This State Occurring}}\
0.2 \
0.6 \
 0.2 
\end{array}
\begin{array}{l}
\
\underline{\text {A A}}\
3 0 \% \
10 \% \
-5 \% 
\end{array}
\begin{array}{l}
\
\underline{\text {BB}}\
-10 \% \
5 \% \
50 \% 
\end{array}
\end{array}$
 We can conclude from the above information that any rational,risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Quizplus · Accepted Answer

The decision for a risk-averse investor to add Security AA or BB to a well-diversified portfolio depends not only on the returns in different states but also on the overall expected return and risk (volatility) of each security. Without calculating and comparing the expected returns and the risks (standard deviation or variance) of both securities, we cannot conclusively determine which security a rational, risk-averse investor would prefer.

The Distributions of Rates of Return for Companies AA and BB