03-PS7-PT

03-PS7-PT - MIT Sloan School of Management J. Wang E52-456...

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MIT Sloan School of Management J. Wang 15.407 E52-456 Fall 2003 Problem Set 7: Portfolio Choice Due: November 25, 2003 1. (BKM) Which statement(s) about portfolio diversification is correct? (a) Proper diversification can reduce or eliminate systematic risk. (b) Diversification reduces the portfolio’s expected return because it reduces the port- folio’s total risk. (c) As more securities are added to a portfolio, total risk would typically be expected to fall at a decreasing rate. (d) The risk-reducing benefits of diversification do not occur meaningfully until at least 30 individual securities are included in the portfolio. 2. Consider the following scenario: There are an infinite number of stocks in the economy, and each of them has a annual volatility (standard deviation) of 30%. The covariance between any two stocks are 0.01. The risk-free rate is 5%. (a) What is the magnitude of the systematic risk in the stock market? (b) Assuming perfect market (no trading cost, short sell allowed, etc) is it still possible for some stocks in the market to have different expected returns? 3.
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03-PS7-PT - MIT Sloan School of Management J. Wang E52-456...

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