Question

1. In a low interest rate environment, should firms use debt or equity to finance an expansion into new markets? Explain your answer.

2. In your own words, describe the difference between a stock portfolio and a stock index. How are stock indexes constructed? Include an example.

3.Can a diversified portfolio guarantee that the investor's money will not be lost? Explain. Include a brief description of the relationship between portfolio diversification and risk.

Answer 1

1. In the low interest rate environment, the firm should be using a higher amount of debt capital in order to finance and expansion into new market because it will have to Incur very low rate off of interest in respect to overall financing and it can explore the growth opportunity to the maximum extent, because the rate of return on these expansion will be easily able to bear with the risk which is minimal due to lower rate of interest and hence the fixed repayment of the company will be lower and has the company should be trying to go for the debt capital rather than equity capital. it will lead to savings in the overall cost and it will also mean that the company will be able to clock higher growth due to lower cost.

2. Stock index is a combination of various different stocks and they are representative of the overall market whereas stock portfolio is a individual constructed portfolio which will be changing time to time.

Stock index are constructed by Value weighting flor price weighting of different stocks.

Example of stock index will be Dow Jones Industrial Average

3 . No, diversified portfolio just eliminate the unsystematic risk but it never guarantee that money will not be lost because portfolio diversification will be just leading to elimination of the unsystematic risk and unsystematic risk will still be present even after the diversification so there can be loss related to systematic risk of the portfolio and hence portfolio diversification will never guarantee protection from capital erosion.