Diversification In Stock Portfolio Paper
Financial Management: FIN 534
Diversification in Stock Portfolio
Diversification in Stock Portfolio
Background
As a risk averse investor, I am considering investing in one of two economies. The expected return with volatility of all stocks in both economies is the same. In the first economy, all stocks move together, in good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independent; one stock increasing in price has no effect on the prices of other stocks.
Diversified Portfolio
There are certain guidelines I need to consider when investing and creating a diversified portfolio. First, I must be cognitive of my risk capabilities in order to manage risk within my portfolio. …show more content…
For example, a significant political event could affect several of the assets in my portfolio. It is virtually impossible to protect myself against this type of risk. When the stock market averages fall, most individual stocks fall and when interest rates rise nearly all-individual bonds and preferred shares fall in value. Systematic risk cannot be diversified away; the more a portfolio becomes diversified, the more it ends up mirroring the market.
Nonsystematic or security specific risk: This risk pertains to the risk that the price of a specific security or a specific group of securities will change in price to a different degree or in a different direction from the market as a whole. This kind of risk affects a very small number of assets. An example is news that affects a specific stock such as a sudden strike by employees. Diversification is the only way to protect myself from nonsystematic …show more content…
The primary reason for investing in portfolios is diversification, that is, the allocation of funds to a variety of securities in order to reduce risk. As the number of securities held in the portfolio increases, the overall variability of the portfolio’s return, measured by its standard deviation, diminishes very sharply for small portfolios, but falls more gradually for larger combinations. This decline in risk is achieved because the exposure to the risk of volatile securities can be offset by the inclusion of low-risk securities or even high-risk ones, so long as their returns are not closely
Diversification in Stock Portfolio
Diversification in Stock Portfolio
Background
As a risk averse investor, I am considering investing in one of two economies. The expected return with volatility of all stocks in both economies is the same. In the first economy, all stocks move together, in good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independent; one stock increasing in price has no effect on the prices of other stocks.
Diversified Portfolio
There are certain guidelines I need to consider when investing and creating a diversified portfolio. First, I must be cognitive of my risk capabilities in order to manage risk within my portfolio. …show more content…
For example, a significant political event could affect several of the assets in my portfolio. It is virtually impossible to protect myself against this type of risk. When the stock market averages fall, most individual stocks fall and when interest rates rise nearly all-individual bonds and preferred shares fall in value. Systematic risk cannot be diversified away; the more a portfolio becomes diversified, the more it ends up mirroring the market.
Nonsystematic or security specific risk: This risk pertains to the risk that the price of a specific security or a specific group of securities will change in price to a different degree or in a different direction from the market as a whole. This kind of risk affects a very small number of assets. An example is news that affects a specific stock such as a sudden strike by employees. Diversification is the only way to protect myself from nonsystematic …show more content…
The primary reason for investing in portfolios is diversification, that is, the allocation of funds to a variety of securities in order to reduce risk. As the number of securities held in the portfolio increases, the overall variability of the portfolio’s return, measured by its standard deviation, diminishes very sharply for small portfolios, but falls more gradually for larger combinations. This decline in risk is achieved because the exposure to the risk of volatile securities can be offset by the inclusion of low-risk securities or even high-risk ones, so long as their returns are not closely