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.
1. Which of the following assertions is most consistent with finance theory regarding risk and diversification?
A. Stock A would have a higher expected return than stock B and stock Awould have a higher expected return than the market
B. Stock A would have a higher expected return than stock B and stock A would have a lower expected return than the market
C. Stock A would have a lower expected return than stock B and stock A would have a higher expected return than the market
D. Stock A would have a lower expected return than stock B and stock A would have a lower expected return than the market

Answer 1

Answer:

Option A is correct.

Stock A would have a higher expected return than stock B and stock A would have a higher expected return than the market.

Explanation:

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 .