1. Diversification: True or False. Explain your answer. The variances of the ind
ID: 2702289 • Letter: 1
Question
1. Diversification: True or False. Explain your answer.
The variances of the individual assets in the portfolio are the most important characteristic in determining the expected return of a well-diversified portfolio.
2. Portfolio Risk: Explain.
a. If a portfolio has a positive investment in every asset, can the standard deviation on the portfolio be less than that on every asset in the portfolio?
b. If a portfolio has a positive investment in every asset, what about the portfolio beta? Is the portfolio beta less than that of every asset in the portfolio?
3. Short Questions: Explain in One Line
a. What is the beta of a market portfolio?
b. If beta of a stock is one, what you can say about the riskiness of that stock compare?
c. If beta of a stock is greater than one, what you conclude about riskiness of the stock?
d. If the standard deviation of returns of a financial asset is zero, what is your best guess about that financial asset?
4. Discuss the three forms of market efficiency. Explain your point of view on which type of efficiency best represents our capital market.
Discuss the key theories in capital structure briefly. Please use complete sentences. No bullets please.
Explanation / Answer
3. a) Beta is a term used to measure the correlation of volatility of a portfolio against the index in which it resides. The market has a Beta of 1 since it IS the market. Your portfolio would be more volatile than the market if it had a Beta higher than 1. Conversely, if your portfolio had a Beta of less than 1, it means that you have less volatility than the market.
As an eample, let%u2019s say that you owned 20 stocks found in the S&P 500 and that the index (the S&P 500) returned 10% over the last 5 years. If your portfolio returned 10% but had a Beta of 0.5 than your portfolio (from a risk versus return point of view) was better than holding the index. This is because your portfolio had HALF the volatility of the index, yet produced similar returns.
Beta is useful information (and widely available information) when looking at mutual funds. If you see a mutual fund that has the same 10 year return as the market but the Beta is 1 or higher, is it worth owning? If you can find a fund that matches or exceeds market performance with a Beta below 1, than that would be a much better choice since your risk-adjusted returns would be higher %u2013 or in other words, you are getting all the returns, with less volatility!
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