1. Why is it better to own 2 or more stocks instead of just 1? 2....

1. Why is it better to own 2 or more stocks instead of just 1?

2. Does the total rate of return formula consider the time value of money (i.e. is it annualized like a growth rate)?

3. a. True/False: Investors prefer high coefficients of variation.
b. True/False: Diversification can remove ALL risk.

4. CAPM and SML are modified versions of what model?

Expert Solution

Answer -

1. It is better to own 2 or more stock instead of 1 as it may decrease the systematic risks in the portfolio.By spreading your investments among a variety of asset alternatives, you can reduce the effect of any one negative result on your whole portfolio so you end up with lower overall investment risk. The structure of a well-diversified portfolio is designed to perform reasonably well in nearly all circumstances.

2. There are two types of formula for calculating rate of return :-

a. Real rate of return - this considers the effect of the time value of money and inflation, the real rate of return can also be defined as the net amount of discounted cash flows received on an investment after adjusting for inflation. This is also called as time time weighted rate of return.

b. Nominal Rate of return :- This does not consider time value of money. It is calculated by following formula

RoR = value at the end - value in the begining + Between the year cash flows / value in the begining

The Difference Between TWR and ROR

A rate of return (ROR) is the net gain or loss on an investment over a specified time period, expressed as a percentage of the investment’s initial cost. Gains on investments are defined as income received plus any capital gains realized on the sale of the investment.

However, the rate of return calculation does not account for the cash flow differences the portfolio whereas the TWR accounts for all deposits and withdrawals in determining the rate of return.

3. False - Normally an investor prefer low risk which is indicated by coefficient of variance so they prefer low coefficients of variation but it also depends upon the risk appetite of investor.

4. False - Since diversification can only remove systematic risks.

jeff jeffy answered 2 years ago

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