Portfolio Theory Questions

Question 1

Explain the relationship between risk and return
Explain the concept of diversification
Explain concepts of market risk and unique risk
Highlight

Answer 1

• linear relationship between risk and return (high risk, high return)
• two types of risk: market and unique
• market= risk factors affecting the economy as a whole
• unique= risk factors affecting a specific company/ firm
• market risk cannot be diversified
• unique risk can be eliminated by diversification
• diversification= strategy designed to lower risk by spreading the portfolio across many investments
• there are theoretical models which allow us to capture this risk return relationship (CAPM)