Question

Q1: Critically evaluate the following statement: Playing the stock market is like gambling. Such speculative investing has no social value other than the pleasure people get from this form of gambling.

Q2: In broad terms, why is some risk diversifiable? Why are some risks nondiversifiable?

Please answer BOTH questions thoroughly and dont copy and paste! looking for original answers only

Answer 1

Outcome of gambling is not under control whereas investor in stock market has certain control. The investors can manage unsystematic risk by diversifying the portfolio or going with market index funds. Over the long run index fund have always given higher returns. Investing in stock market involves lots of technical and qualitative research like financial statement analysis, ratio analysis, the solvency, profitability and credit worthiness of the company. Investing in stocks can be planned well and unlike gambling risks can be minimized to certain extent while maintaining a proper minimum expected return. However uninformed trading or buying shares without analysis and just based on the whims and fancies of the investor is gambling. The uncertainty part of share market can be managed by doing qualitative research about companies and industries. Certain companies outperform their peers due to superior technology and competitive advantage. By analyzing the products and the market response of their products or service scan be good indicator about the potential returns. In my opinion stock market is not gambling if done with research and analysis.

Some risk (E.g. strikes in a particular company. Increase in raw material cost for a particular industry, which are company or industry related risk) can be diversified. by investing in index market portfolio. These risks can be controlled by diversification. Financial and business risks are the main risks which can be minimized by diversification.

Some risks are non-diversifiable because they affect all the industries and companies. The risks like interest rate risk, tax rate, inflation, etc. cannot be controlled as they are macroeconomic factors and affect the entire economy. The interest rate risk, purchasing power risk and market risk cannot be diversified.


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