Assignment3Finance - Leslie Martin-Freeman Diversification...

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Leslie Martin-Freeman Diversification in Stock Portfolios Financial Management – FIN 534 Prof. Diana Bonina, Ph.D. Date: 11/19/2010 Assignment #3 Page 1
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You should choose the second economy. An investor is said to be risk averse if he prefers less risk to more risk, all else being equal. Portfolio theory tells us that such an investor will require compensation for taking systematic risk , because the risk can be diversified away in a large portfolio. Assuming you have a balanced portfolio of stocks in each economy, the better economy for you to invest in is the second one. In the first economy, if the entire economy declines, then your entire portfolio declines. However, in the second economy, if the economy declines, some of your stocks will decline, and others will increase because stock returns are independent (Berk, J., & DeMarzo, P. (2011). Thus, your portfolio will be better diversified if you choose the second economy; this is preferable because you are risk averse. In this economy, the investor would be able to diversity and therefore decrease his or her risk. In the first economy, he would either be up or down on all holdings, and if they were down, he could lose a lot. By
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This note was uploaded on 11/02/2011 for the course FINANCE FIN534 taught by Professor Shirleyjohnson during the Spring '10 term at Strayer.

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Assignment3Finance - Leslie Martin-Freeman Diversification...

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