Question

a. Suppose Emma holds a well-diversified stock portfolio. Her son, Andrew, who is a portfolio manager, has just advised her not to invest in stocks of oil refining industry because their prices tend to have much higher volatility relative to other stocks. Is Andrew’s advice sound? Explain.

Answer 1

The prices of oil have recently shown that they are more volatile than the stocks and their prices in derivative segment have even slided into the negative zones, and that was completely unexpected because it has never happened before in the history of commodity market.

In this case,Emma already holds a well diversified portfolio and she wants to take exposure in commodity sector by investing into oil. I would recommend har to allocate very little amount of portfolio in this commodity because this commodity is highly dependent upon the fixation of price of various member nation of OPEC, and it is highly fluctuating in nature so that it will have a higher level of uncertainty attached with because of difference due to pricing of different member nations.

Since her portfolio is already well-diversified, she should not be fearful of investing into oil industry because it has corrected sharply and it will have value because it has the potential to rebound on the way upside, when the normal environment returns, so it would be very courageous but very rewarding to invest into oil at this point of time, where it has corrected significantly and even sliding into the negative zones.

I would advocate against the advice of her son because she should be investing into oil, although only a little proportion of a portfolio, in order to gain from potential opside movement in the long term, as it is more precious than what is being demonstrated in its price at present.