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Finance Stock Investing and Risk Required Rate of Return

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1. How can it be possible to invest in two stocks and have less risk than if you invested all your money in only one of them?

2. Explain why a foreign investment project might have a lower required return than an otherwise-identical domestic project.

3. What is the relationship between interest rates and bond prices? When must the yield to maturity of a bond equal the current yield? What makes some bonds sell at a premium while others sell at a discount?

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Finance stock investing and risk required rate of return is examined.

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How can it be possible to invest in two stocks and have less risk than if you invested all your money in only one of them?

Investing in one stock leads to stand alone risk. Here the stand alone risk is referred as an un-diversifiable risk cause by infesting into a single asset. Investing in more than one stock is called portfolio creation. Portfolio investment is done when the investor tries to invest his money in two or more different assets. As different assets have different risk associated with them pooling them into one portfolio diversifies the risk of the portfolio.

For example: Suppose you are trying to create a portfolio of stocks and Treasury bond. If the stocks selected for investment are Wal-Mart, Microsoft and Adobe and the investment in short term treasury bills.
As we know that,
Beta for Wal-Mart=0.3
Beta for Microsoft Corporation =1.01
Beta for Adobe =1.71
Beta for T-bills=0
25% of weight is given to all the assets

If the investor invests only in Adobe shares it will have an un-diversifiable systematic risk of 1.71. But as ...

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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