investments chapter 16

investments chapter 16 - portfolio without thinking....

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MGT 3440 Chapter 16 Questions and Problems Briefly, why is diversification a good idea? Diversification is a good idea because like the old saying goes “Don’t put all your eggs in one basket.” This saying has held strong for quite a long time, but not without good reason. You want to have a good blend of stocks, bonds, and cash accounts when investing. More importantly, you want to have a good diverse portfolio within those accounts, such as energy stocks, tech stocks, blue-chip stocks, etc. The idea behind it is to have a bit of money in your account in all parts of the market for a good return on your money in the long run. What is meant by unnecessary risk? Unnecessary risk is meant that investors are only rewarded for bearing necessary risk. Diversifiable risk is unnecessary, and this is because every single rational investor should have a diverse
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Unformatted text preview: portfolio without thinking. Research shows that diversification reduces necessary risk by about 75%, meaning that when you invest, only 25% of what you put into the market is really “vulnerable” to loss at any given time. Suppose two securities have perfect negative correlation. Would it make sense to invest in these two securities only? No it would not. The two securities cancel each other out when one is high; the other is low to correspond correctly. Combined in the same account, they will achieve a lower rate of return, but also will cancel the risk along with it. Having other securities in the portfolio will only help you benefit in the long run, and achieve and even higher return....
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This homework help was uploaded on 04/18/2008 for the course MGT 3440 taught by Professor Gummerson during the Fall '07 term at St. Scholastica.

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