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You work for an investment firm and recently wrote a position article on your firm's approach to risk. The article now appears on your company's website. It has, interestingly enough, generated e-mailed responses from potential clients and your firm is asking you to address some of their questions for a Frequently Asked Questions (FAQ) segment that will be posted to the site soon. Specifically, some of the respondents have compared investing in the stock market with gambling and state that even some of the financial press have advocated for "dart throwing"- meaning it does not really matter which stocks to choose as returns on all the stocks are similar. These respondents would like a response that further clarifies your firm's position regarding risk in light of these type of statements.

Knowing that both stock investing and Las-Vegas-style gambling do have elements of risk in them, how do you compare the two? Are there any similarities between them? What about dart throwing? In your response, your company has asked that you address these questions building upon the risk-return concepts you identified in the position piece you wrote for the firm.

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Solution Preview

The purpose of the question is to make you compare the level of risk involved in gambling and in stock investing. There is an interesting idea that pasting the names of the stocks on a dart throwing board and randomly throwing darts can combine the two. The proposition is that a portfolio chosen randomly will perform as well as a carefully chosen portfolio by an investment firm. That the work done by an investment firm does not bring any visible benefit to the investor. Also included in the question is the direct comparison of gambling with stock investing. You are required to point out the various risks inherent in stock investing and also state how these risks are qualitatively different from the risks, which are encountered by a gambler at Las Vegas. The direct challenge is that if the financial analyst performs no better than randomly selected stocks then the financial analyst becomes redundant.
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<br>The question makes several assumptions, first the question assumes that dart throwing refers to a game of chance, but dart throwing is a game of skill that can be perfected to a great extent. Second, the financial press has presumed that the names of the stocks can be pasted on the dart throwing board and that a random throw of dart can be used to select the stocks. This random ...

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