(4 marks) Explain why portfolio risk (sp) tends to decrease as the number of stocks in...

Explain why portfolio risk (s_p) tends to decrease as the number of stocks in the portfolio increases.

Expert Solution

The portfolio risk tends to decrease when the number of stocks go up in a portfolio due to the effects of diversification. The more the number of securities held, the higher the proportion of reducing the risk of unexpected losses due to changes in returns or prices of the stock. It follows a natural rule that not all stocks will reduce in prices at go nor all stocks will increase their prices and hence having a wide variety of stocks balances the overall portfolio risk. Also, when the number of assets grow ,the terms in the formula for variance also grow in an exponential manner which brings down the risk. As well, the weights in each asset and the correlation among the stocks determine the riskiness and a prudent investor will most certainly invest few stocks that have high correlation and few in those that have low correlation which ultimately smoothens the returns of the portfolio over time.

jeff jeffy answered 1 year ago

Explain why portfolio risk (sp) tends to decrease as the number of stocks in the portfolio...

Explain why portfolio risk (sp) tends to decrease as the number of stocks in the portfolio increases.

True or False: Increasing the number of stocks in a portfolio reduces market risk. A) True...

True or False: Increasing the number of stocks in a portfolio reduces market risk. A) True B) False Consider two stock portfolios. Portfolio A consists of four different stocks from firms in different industries. Portfolio B consists of 10 different stocks, also from firms in different industries. The return on Portfolio A is likely to be 1) ________ (MORE or LESS) volatile than that of Portfolio B. Suppose a stock analyst recommends buying stock in the following companies: Company Industry...

1-risk and portfolio How we decrease the risk in a portfolio? What actions should we follow?...

1-risk and portfolio How we decrease the risk in a portfolio? What actions should we follow? 2-investor and stock markets What is the biggest fear for an investor? In your opinion, what is it that should bother the investor the most?

Discuss why diversification is important as risk management strategy within a portfolio of investment. (8 marks).

Discuss why diversification is important as risk management strategy within a portfolio of investment. .

Discuss why diversification is important as risk management strategy within a portfolio of investment. (6 marks)

Discuss why diversification is important as risk management strategy within a portfolio of investment.

Explain the graph below. Talk about market risk, firm-specific risk, diversification and number of stocks in...

Explain the graph below. Talk about market risk, firm-specific risk, diversification and number of stocks in a portfolio Does that mean you need to buy at least 20 stocks? What are the possible scenario that someone is not diversified at all with more than 20 stocks in his/her portfolio?

Explain how total portfolio risk can be decomposed in various risk exposures and indicate why risk...

Explain how total portfolio risk can be decomposed in various risk exposures and indicate why risk decomposition can be a complex exercise.

Management tends to focus on residual risk instead of inherent risk. Why do you think this...

Management tends to focus on residual risk instead of inherent risk. Why do you think this is so? Why should internal auditors consider both inherent risk and residual risk when planning an assurance engagement?

You are a fund manager and have a portfolio of high risk stocks. The beta of...

You are a fund manager and have a portfolio of high risk stocks. The beta of a firm is more likely to be high under which two conditions? A. high cylical busniess activity and high operating leverage B. high cylical business activity and low operating leverage C. low cylical business activity and low financial leverage D. low cylical business activity and low operating leverage E. low financial leverage and low operating leverage

Question