Question

Question 1.(Answer all parts)(a) Many investors choose a variety of investments (e.g. shares, bonds, cash, or property) in a diversified portfolio whilst others have only one or two investments. Explain the impact of a diversified portfolio on risk and how it relates to Total risk.(b) Explain the relationship between a company announcement and the return on an investment according to the Efficient Market Hypothesis.(c) Which Market Form best represents the current Australian Securities Exchange?Why?(1 Mark)

Answer 1

01.(a) The impact of a diversified portfolio on risk and how it relates to Total risk :

Risk defines uncertainty in the future return. Suppose one investor invested $ 500 in a financial asset. During the bad economic condition, his invested capital may value to $ 400. So the risk is $ 100.   Even if the scenario goes the worst price of the assets may fall further to $ 300 and the risk becomes $ 200.

Now think about the scenario instead of investing in a single asset the investor invested in Assets combination of Real estate, Secured Govt Bonds and Share. So His expected future return in percentage will be reduced due to this diversified portfolio. But on the other hand, even during bad economic condition govt bonds price will not depreciate will continue to generate a consistent return. The price of real estate may fall but fluctuation will be very less as compared to stock. So a diversified portfolio of different asset class reduces the total risk of investment.

(b) Explain the relationship between a company announcement and the return on investment according to the Efficient Market Hypothesis.

As per the Efficient Market Hypothesis 03 forms of market exist and the affect of a company announcement will be different

1. Strong Form: When a company announcement is done may be good or bad immediately its effect reflected on its price. Information related to the firm is readily available to everyone. Every investor is able to take investment decisions from the information available.
2. Semi Strong Form: Information related to company announcement is public . But the decision taken by every investor is not the same as the interpretation goes wrong/different at every level. Also the flow of information to the public maybe not real-time. This type of market efficiency. Just think about the scenario of database providers like Bloomberg all public information only provided. But the flow of the data and presented with real-time help few investors to take early action even on public announcement.
3. Weak Form: Here the flow of information related to company announcement completely asymmetric. So only a few investors will be able to generate a return through this form of market.

(c) Which Market Form best represents the current Australian Securities Exchange? Why?

• The current Australian Securities Exchange describes Semi Strong Form of Market Form. As described public information is readily available to everyone. But efficient use of the information by few investors/analysts may give some early advantages to them.