Corporate Finance Essay Example | Topics and Well Written Essays - 1000 words

Corporate Finance - Essay ExampleI match to this because diversification spreads the risk over the different types of assets. Given the fact that the two assets ar uncorrelated to each former(a), it would be rational to invest in both assets. The higher risk of asset S will be compensated with the little risky return of asset B. 2. I totally disagree to the statement it is quite opposite of the fact that there is a direct relationship betwixt correlation of the portfolio assets and its risk. The higher the correlation amid the portfolio assets, the more chances will be that the downside movement of one asset will accompany the same in the other and thus the investment will turned to be the worst. Thus, a rational investor should invest in uncorrelated or atleast less correlated assets in set up to reduce the overall risk of the portfolio (Ross et. al, 2013). 3. I agree to this argument. Since the expected return of portfolio is the weighted average of the expected returns of th e singular assets, it must lie in between the range of these two individual expected returns. . However, the standard deviation of the return on portfolio doesnt need to be in b/w the individual standard deviations of the two assets, especially when the stocks are uncorrelated, because the standard deviation of a portfolio is not just the weighted average of individual standard deviations but is computed using the standard deviation formula to the return on portfolio assets rather than just the returns for one asset... al, 2013). 4. I agree to this statement. When capital market consists of all risky assets, a rational investor should hold large weigh of assets in portfolio in order to diversify risks to a large extent. Risk diversified over the large number of stocks will tend to reduce the portfolio risk more signifi butt jointtly because a large portfolio tends to behave more like the market portfolio which compensates unsystematic risks (Ross et. al, 2013). 5. I agree to this statement. The variability of the return on a portfolio is function of both the component variances of the individual assets as well as co-variances among the assets returns (Ross et. al, 2013). That is, even if the individual variances of the assets are precise low though their returns are highly correlated, the portfolio will be highly volatile and risky and there wont be any service of such diversification. 6. I disagree. Although increasing the number of assets reduces the variance of portfolio return because of diversification, the reduction in risk occurs at a diminishing rate (not at a constant rate) with the increase in number of assets in the portfolio. It is even said that to attain the maximum benefits of diversification, 10-15 assets are enough for a portfolio since this amount of diversified assets can resemble the market portfolio. Adding more assets wont contribute to any further reduction in the portfolio risk. So, the variance will be more or less same but wont be zero even when N is very large. Also, its not just the added number of assets which reduces the portfolio variance but the correlation between the assets does that too. Theoretically, a mix of negatively and positively correlated assets or a mix of uncorrelated