Question

1) Please describe the meaning of diversification. How does diversification reduce risk for the investor?

2) How do investors measure the risk of individual common stocks?

Answer 1

Ans 1 Diversification meaning owning different characteristics stocks such that all stocks doesn't behaves in similar manner with the market. This is done so as to reduce market and credit risk of the portfolio . As you will have many stocks and the probability of all stocks going down at a time with market becomes less , this diversification technique is adopted .

Ans 2 Investors measure risk of individual stock by measuring beta and standard deviation of stock return. Beta tells the correlation between market and the stock . And standard devaitide of stock return can be used to calculate the probability of deviation of returns from mean return .