Suppose an individual investor starts with a portfolio that consists of one randomly selected stock.
a. What will happen to the portfolioâs risk if more and more randomly selected stocks are added?
b. What are the implications for investors? Do portfolio effects have an impact on the way investors should think about the riskiness of individual securities?
c. Explain the differences between stand-alone risk, diversifiable risk, and portfolio risk.
d. Suppose that you choose to hold a single stock investment in isolation. Should you expect to be compensated for all of the risk that you assume?
Suppose an individual investor starts with a portfolio that consists of one randomly selected stock.
a. What will happen to the portfolioâs risk if more and more randomly selected stocks are added?
b. What are the implications for investors? Do portfolio effects have an impact on the way investors should think about the riskiness of individual securities?
c. Explain the differences between stand-alone risk, diversifiable risk, and portfolio risk.
d. Suppose that you choose to hold a single stock investment in isolation. Should you expect to be compensated for all of the risk that you assume?
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Related questions
The client of Cicero Services owns a bond portfolio with $1 million invested in zero coupon Treasury bonds that mature in 10 years. The client also has $2 million invested in the stock of Blandy, Inc., a company that produces meat-and-potatoes frozen dinners.
The Congress and the President are engaged in an acrimonious dispute over the budget and debt, which will not be resolved until the end of the year. The financial planner task is to determine the risk of the clientâs bond portfolio. The five possible scenarios for the resolution with the probability of the scenario occurring and the impact on interest rate and bond prices. The rate of return on 10-year zero coupon for each scenario are shown below:
| Scenario | Probability | Return |
| Worst Case | 0.10 | -14% |
| Poor Case | 0.20 | -4% |
| Most Likely | 0.40 | 6% |
| Good Case | 0.20 | 16% |
| Best Case | 0.10 | 26% |
| 1.00 |
The historiacal returns for the past 10 years for Blandy, Corp., and the stock market are:
| Year | Market | Blandy | Gourmange |
| 1 | 30% | 26% | 47% |
| 2 | 7% | 15% | -54% |
| 3 | 18% | -14% | 15% |
| 4 | -22% | -15% | 7% |
| 5 | -14% | 2% | -28% |
| 6 | 10% | -18% | 40% |
| 7 | 26% | 42% | 17% |
| 8 | -10% | 30% | -23% |
| 9 | -3% | -32% | -4% |
| 10 | 38% | 28% | 75% |
Average return: 8.0% 9.2%
Standard Deviation: 20.1% 38.6%
Correlation with the market: 1.00 0.678
Beta: 1.00 1.30
1. Should portfolio effect influence how investors think about the risk of individual stock?
2. If you decide to to hold a one-stock portfolio and were exposed to more risk than diversified investors, could you expect to be compensated for all your risk and earn risk premium on that part of your risk that you could have eliminated by diversifying?
3. According to the Capital Asset Pricing Model, hat measures the amount of risk that an individual stock contributes to a well diversified portfolio? Define these measurements.
4. What does the market equilibrum mean? If equilibrum does not exist, how will it be established?
5. hat is the Efficient Markets Hypothesis (EMH) and what are its three forms? What evidence supports the EMH? What evidence casts doubt on the EMH?