Question

⦁ A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills were paying 4.5%. You are considering adding one more stock to your portfolio, the stock will boost the portfolio’s expected return to 20% while also increases the standard deviation to 30%. Should you add the stock? Why or why not?

Answer 1

You should add to the stock

Explanation:

As per sharpe ratio

Sharpe ratio = (Mean portfolio return − Risk-free rate)/Standard deviation of portfolio return

Before,

= (15%-4.5%)/25%

= 0.42

After,

= (20%-4.5%)/30%

= 0.5167

Since sharpe ratio is increased after addition of stock, stock should be added.

Sharpe ratio is used to measure the risk return relationship of overall portfolio after addition of new stock, and higher the ratio , better the addition.