What formulas do investors use to diversify risk out of their portfolio? How might a portfolio - 12838

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1. Let’s consider Portfolio Diversification.  Investors diversify their portfolio in order to ensure a certain type of return.  What formulas do investors use to diversify risk out of their portfolio?  How might a portfolio be enhanced with international and domestic investments?

 

2. An efficient markets assumes the following characteristics: many small investors, all having the same information and expectations with respect to securities; no restrictions on investments, no taxes, and no transaction costs; and rational investors, who view securities similarly and are risk adverse, preferring higher returns and lower risk. Assuming an efficient market, how might we use the CAPM model to explain the behavior of security prices?

 

3. Diversifying your portfolio helps to avoid losses.  Stocks are considered risky when their value often changes dramatically. How might you use Coefficient of Variation to determine the riskiness of a single asset? How do you determine the weighted average returns of a portfolio? 

 

4. In our reading we learned that LLC's work well for corporate joint ventures or projects developed through a subsidiary (Pearson, Addison-Weley, 2006).  UPS has used a LLC as a joint venture structure in order to gain use of the assets (trucks and planes) of another organization.  Why do you think they would do this instead of purchasing the assets themselves?

 you think corporations use LLC's to offset risk?  What are other examples they may want to use a LLC structure for joint ventures?  Are there any examples in the recent news? 

 

6. How can the Free Cash Flow Model be used to determine the value of an organization? 

 

 

Solution Description

1. Let’s consider Portfolio Diversification.  Investors diversify their portfolio in order to ensure a certain type of return.  What formulas do investors use to diversify risk out of their portfolio?  How might a portfolio be enhanced with international and domestic investments?

 

By diversifying a stock portfolio, an investor invests in different stocks that react in a different way to a given event. This helps the investor diversify the risk faced in the investment. A usual portfolio should consist of five stocks, each from a different sector.  These stocks should react different at different points in a business cycle. When different stocks are carefully selected, the diverse stock portfolio spreads the risk of the investor. For example if an investor has chosen a manufacturing company and a bank stock as a part of his or her portfolio, when the interest rates go up, the profits and hence the price of the stock of manufacturing organization will go down, but at the same time the bank will make greater profit and the price of its stock will go up. Investors use formulas that measure risks in certain investments such as the risk be