What is the correlation coefficient? What is diversification? Distinguish between systematic and unsystematic risk. What is...

What is the correlation coefficient?
What is diversification?
Distinguish between systematic and unsystematic risk.
What is the risk premium?
Define beta

Solutions

Expert Solution

Correlation coefficient is ratio obtained from covariance of assets divided by the multiplication of standard deviation of asset. Higher the correlation more closely is the return on of 2 assets are related.
Diversification is the benefit obtained by choosing a portfolio with negative correlation and reducing unsystematic risk.

Systematic risk is the non diversifiable economic risk affecting the entire economy and all industries like interest rate and inflation whereas unsystematic risk is the diversifiable risk which can be reduced by choosing negatively correlated stocks in the portfolio.

Risk premium is the excess return of portfolio over the risk free rate.

Beta is the relation of risk premium of portfolio and risk premium of market. It is obtained by taking the covariance of stock
and market return divided by variance of market.

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