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Total Risk, Non-Diversifiable Risk and Diversifiable Risk

Questions: # 1: How are the total risk, non-diversifiable risk, and diversifiable risk related? Why is non-diversifiable risk regarded as the only relevant risk? Do you agree this is correct?

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Questions: # 2: What is the difference between Firm's Operating cycle and cash conversion cycle? Which would be more important to you as an owner and why?

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Questions: # 3: Discuss NPV and IRR. Does the assumption concerning the reinvestment of intermediate cash inflow tend to favor NPV or IRR? Which technique is preferred in practice and why?

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DEAR STUDENT,

Questions: # 1: How are the total risk, non-diversifiable risk, and diversifiable risk related? Why is non-diversifiable risk regarded as the only relevant risk? Do you agree this is correct?

Total risk is systematic risk and unsystematic risk of an investment. Systematic risk is the risk associated with entire class of assets. However, unsystematic risk is unique to the particular investment.
Unsystematic risk is also called as diversifiable risk. Diversifiable risk is the risk of price change due to the unique features of the particular security and it is not dependent on the overall market conditions. Diversifiable risk can be eliminated by diversification in the portfolio.
Non-diversifiable risk is the risk common to the entire class of assets or liabilities. The value of investment decline over the period due to the changes in the economic conditions of the country or any changes which affect the major portion of the market. Non-diversifiable risk is also called as systematic risk.
Non-diversifiable risk is also called market risk since the risk is associated with market conditions. Total risk, diversifiable risk and non -diversifiable risk are related with each other as diversifiable and non-diversifiable risk are part of total risk.
A systematic risk is beyond the control it is not relevant for decision making as anything uncontrollable is not relevant for the decision making. Unsystematic risk is relevant for decision making. Therefore , diversifiable risk is relevant for the decision making.
Therefore, it is incorrect to say that only non-diversifiable risk is relevant for the decision making.

Questions: # 2: What is the difference between Firm's Operating cycle and cash conversion cycle? Which would be more important to you as an owner and why?
Operating cycle is the average time between ...

Solution Summary

The expert determines how total risk, non-diversifiable risk and diversifiable risk are related.

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