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Considering the effects of diversification, how should Sarah respond to the suggestion that you invest 100 percent of your 401(k) account in East Coast Yachts stock?

You are discussing your 401(k) with Dan Ervin, when he mentions that Sarah Brown, a representative from Bledsoe Financial Services, is visiting East Coast Yachts today. You decide that you should meet with Sarah, so Dan sets up an appointment for you later in the day.

When you sit down with Sarah, she discusses the various investment options available in the company’s 401(k) account. You mention to Sarah that you researched East Coast Yachts before you accepted your new job. You are confident in management’s ability to lead the company. Analysis of the company has led to your belief that the company is growing and will achieve a greater market share in the future. You also feel you should support your employer. Given these considerations, along with the fact that you are a conservative investor, you are leaning toward investing 100 percent of your 401(k) account in East Coast Yachts.

Assume the risk-free rate is the historical average risk-free rate. The correlation between the bond fund and the large cap stock fund is .16

  1. Considering the effects of diversification, how should Sarah respond to the suggestion that you invest 100 percent of your 401(k) account in East Coast Yachts stock?

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