Amy considers two investment opportunities (Stock A and Stock B) with the same price per unit in the market. The payoff per unit invested in Stock A and Stock B has the same distribution. Amy wants to buy Stock A and asks for opinions from her friend Tom, who is a financial advisor and knows Amy is risk averse. Tom suggests Amy should consider a portfolio comprising both of the stocks, rather than put all money on a single stock. Use the expected utility theory to explain Tom's suggestion.

Amy considers two investment opportunities (Stock A and Stock B) with the same price per unit in the market. The payoff per unit invested in Stock A and Stock B has the same distribution. Amy wants to buy Stock A and asks for opinions from her friend Tom, who is a financial advisor and knows Amy is risk averse. Tom suggests Amy should consider a portfolio comprising both of the stocks, rather than put all money on a single stock. Use the expected utility theory to explain Tom's suggestion.

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter6: Risk And Return

Section: Chapter Questions

Problem 6MC: Your client is shocked at how much risk Blandy stock has and would like to reduce the level of risk....

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