Question

ANSWER QUESTIONS 3 PLEASE

Expected Rate of return
Scenario	Probability	T-Bills	S&P 500	Utility Company	High-Tech Company	Counter-Cyclical Company
Recession	20%	5%	-10%	6%	-25%	20%
Near Recession	20%	5%	-6%	7%	-20%	16%
Normal	30%	5%	12%	9%	15%	12%
Near Boom	10%	5%	15%	11%	25%	-9%
Boom	20%	5%	20%	14%	35%	-20%

Based on the above returns, Jenna calculated the betas of the three stocks as follows:

Beta of Utility Company = 0.22

Beta of High-Tech Company = 2.02

Beta of Counter-Cyclical Company = -1.13

Imagine you are Jenna. Prepare a report for Kevin to help him understand the concepts of risk and return. Include the following things in your report (don’t just copy from the textbook, explain things in your own words):

3) How would you demonstrate the meaning and advantages of diversification to Kevin?

Answer 1

Ans 3) Diversification: It means that diversifying the portfolio among different asset class or stocks. By diversifying one can reduce the risk due to unforseen or adverse market conditions. It generally reduce the standard deviation of portfolio if the stocks are not perfectly correlated. By diversifying one can be less affected by adverse market conditions.

Advantage of diversification:

1. If stocks are not perfectly correlated then it will reduce the risk of the portfolio.

2. It produces higher risk adjusted return.

3. Help in designing optimal portfolio.

4. Helps in generating positive return over the year even market conditions are bad due to presence of the conter cyclical company in the portfolio.

5. One can rebalance portfolio with change in market conditions and earn more return.