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

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

Solutions

Expert Solution

The portfolio risk tends to reduce as the number of securities in a portfolio increases because the as the number of securities in a portfolio increases and if the correlation between the movement of returns of those securities is low then the overall return of the portfolio stabilizes. This is because when the correlation is negative if one stock did not do well then, the other stock did well and the overall return of the portfolio is not significantly negatively affected. This is also known as the diversification. As more securities are added to the portfolio the overall risk of the portfolio reduces then the individual risk of the securities. When we calculate the standard deviation of the portfolio then we not just consider their weight of the portfolio and risk of the individual securities, we do also consider the correlation between the returns of those securities and if the correlation of the returns of securities are negative then the overall risk of the portfolio reduces. It is because having a large number of stocks in the portfolio reduces the volatility of the overall return of the portfolio.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

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

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

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?

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

Risk and Return Sarah is a financial analyst of a portfolio consisting of the stocks shown...

Risk and Return Sarah is a financial analyst of a portfolio consisting of the stocks shown below. The risk free rate is 3% and the market risk premium is 8%. Stock H, Investment $2mil, Beta 1.4 Stock I, Investment $3mil, Beta 1.0 Stock J, Investment $5mil, Beta -0.2 Compute beta and expected return of portfolio.

Systematic Risk is A. eliminated totally if there are over a 30 stocks in your portfolio...

Systematic Risk is A. eliminated totally if there are over a 30 stocks in your portfolio B. the same as unique risk C. the risk from exposure to the market, marcoeconomic factors etc D. the risk arising from the interconnectedness of banks leading to the recession in 2008

Subjects