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Question 8: You expect HGH stock have a

30%

return next year and a

50%

volatility. You have

$100,000

to invest, but plan to invest a total of

$110,000

in HGH, raising the additional

$10,000

by shorting either KBH or LWI stock. Both KBH and LWI have an expected return of

15%

and a volatility of

30%.

If KBH has a correlation of

+0.5

with HGH, and LWI has a correlation of

0.5

with HGH, which stock should you short?

You expect HGH stock have a 30% return next year and a 50% volatility. You have $100,000 to invest, but plan to invest a total of $110,000 in HGH, raising the additional $10,000 by shorting either KBH or LWI stock. Both KBH and LWI have an expected return of 15% and a volatility of 30%. If KBH has a correlation of +0.5 with HGH, and LWI has a correlation of -0.5 with HGH, which stock should you short? Which portfolio is superior? Why? (Select the best choice below.) A. Both portfolios have the same expected return, but shorting KBH is better because we should seek to hold stocks that are positively correlated to reduce volatility. B. Both portfolios have the same expected return, but by shorting KBH, we achieve a lower volatility because it has a positive correlation with HGH. By shorting KBH, some of the common risk shared by the stocks is reduced. C. Both portfolios have the same expected return, but shorting LWI is better because we should seek to hold stocks that are negatively correlated to reduce volatility. D. Both portfolios have the same expected return, but shorting LWI is better because we should seek to hold stocks that are positively correlated to reduce volatility

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