Why does the portfolio risk go down when you include more financial assets in a portfolio

Name and ID ___________________________________

Prince Mohammad Bin Fahd University

Investment and Portfolio Management

(EMBA 4314)

Fall 2020-21

Homework (as per syllabus)

Submission Deadline: November 13, 2020 (Friday before 11.59 pm)

Points: 15 percent of the final grade (6×5=30; will be converted into out of 15)

This is a group homework. You will have exactly the same group that you already submitted to me. No change of group is allowed at this time. So do not change the group composition at any cost.  You will submit the homework by email. It must be hand-written and submitted as one PDF document. One submission per group. You must show your work (calculation) clearly. Finally, please make everything clear in your answer and do not assume that I will be able to read your mind. I will grade what I will see. Late submission or deadline extension will not be allowed. Plagiarism is strictly prohibited.

1. Why does the portfolio risk go down when you include more financial assets in a portfolio? How does it happen?
2. Assume that you have invested in two stock A and B. Stock A has a standard deviation of return of 10 percent. Stock B has a standard deviation of return of 20 percent. The correlation coefficient between the two stocks is 0.60. If you invest 60 percent of your funds in stock A and 40 percent in stock B, what is the standard deviation of your portfolio?
3. Write down the CAPM equation. Define every part of it. How does it help us in financial decision making?
4. You have stock YYY, which has following information: Beta = 1.75; risk-free rate = 4 percent; market rate of return = 12 percent. However, this stock actually gives 16 percent return. What should be the return of this stock? Is it underpriced or overpriced? How will it go to equilibrium price?
5. Describe the concept of required rate of return in details.
6. If you bought stock A for $2000 and sold it for $2400 after 6 months, what is the HPY of your investment? If you bought stock B for $2000 and sold it for $3000 after three years, what is the HPY of your investment? Which investment is better?