Question

Q.   If investor invest in more than one asset (say two assets A and B) then he definitely diversify some of his risk but cannot diversify all of the risk. True/False? Explain your answer.

Answer 1

If an investor is holding more than one assets in his portfolio, then he has to diverse his portfolio in order to reduce risk. However he cannot diversify all his risks. The given statement is true beacuse of following reasons

RISK AND REWARD CONCEPT :

If you are investing in an asset, then definetly there will be risk involved in it and also reward can be determined by considering the amount of risk that you take.

You will diversify a portfolio in different assets in order to reduce risk. However you cannot diversify all of the risk. I can explain this by using following example.

Suppose i have two assets say Asset A which consists of Equity stocks and Asset B which consists of Gold.

Whenever the stock market is down, the value of stock comes down and at the same time gold prices increase which inturn makes profit in my Asset B. We cannot say that loss we incurred on reduction stock preice can be totally gained by imcrease in gold prices. Both assets are different and its loss values and gain values will be different. And it also depends on weights that i will be giving to asset A and asset B.

You can maintain your portfolio in such a way that if one asset is in loss other asset should be in profitable situation. But it is not possible to diversify all risk that is associated with the portfolio.

If you want to have riskless portfolio,it is better to invest in savings acount and Sovereign bonds.