Investor Diversification
Some investment assets have a diversifiable risk and some have an undiversifiable risk involved. Diversifiable risk is specific to a particular security or sector, so its impact on a diversified portfolio is limited to that particular security (moneyterms.co.uk). For example, a financial crisis in a country can cause diversifiable risk on the investments pertaining to the financial institutions. Undiversifiable risk is the tendency of stock prices to decrease, which is caused by something that affects returns on all stock in the same manner, such as war or an interest rate change (Legal).
A substantial unexpected increase in inflation would be an undiversifiable risk because it is common to an entire class of assets or liabilities, or all the stock on the market. It is also considered a market risk or a systematic risk. The economy expects prices to rise slowly over a period of time. That goes along with the economic growth. A substantial unexpected increase in prices can cause the sales in the economy to slow down because consumers may not view the product as having the value of the unexpected substantial increase in price. This activity affects the revenue in a company, which in turn, affects the stock prices.
A major recession in the economy is an undiversifiable risk because it affects the overall market conditions, more especially when unemployment is on the rise and spending is on a slowdown. Even though different parts of the market will have different affects...
This is another market risk when it comes to investments of stock and other high risk assets.
A major lawsuit against a large publicly traded corporation is a diversifiable risk because it is only against the stock of that specific corporation. Corporations usually expect lawsuits to a certain degree and allow for it in the budget, but a major lawsuit could have substantial damage, depending on the circumstances of the lawsuit. More especially corporations, such as Google, Inc., face this with the assets of patents. The stock prices of these corporations could be affected in major ways if another company wins a lawsuit on infringement of rights against Google, Inc. Or, if someone else tries to use the rights of the patents that are owned by Google, Inc., it could affect the stock price with the legal costs of the battle and the loss of sales resulting from the incident.
The expected rate of return on the market portfolio would be seven percent given that the expected rate of return on asset "i" is 12%, the risk-free rate is 4%, and the beta is 1.2. The risk free rate is four percent given that the expected rate of return on asset "j" is 9%, the expected rate of return on the market portfolio is 10%, and the beta is 0.8.
Determining the beta for a portfolio that contains half the stocks traded on the major exchanges would need to be…
