More can be said about risk, especially as to its nature, when we own more than one asset in our...

Question:

More can be said about risk, especially as to its nature, when we own more than one asset in our investment portfolio. Define risk and explain how risk is affected if we diversify our investment by holding a variety of securities?

Portfolio of securities:

Portfolio of securities refers to the group of securities in which an investor can invest. It consists of various securities such as shares, bonds, mutual funds and other financial instruments having different risk and returns.

Answer and Explanation:

Risk: Risk can be defined as the chances that the expected results or return from an investment will differ from the actual return. Risk is associated with the uncertainties which are related to the outcomes.

Effect on risk:

The risk of the portfolio will decrease when the investor holds different securities in the portfolio as the securities will have different risk and returns. So, if the investor suffers loss from one security, the loss can be set off from the profit earned through other securities. Hence, the risk of loss of the principal amount invested reduces. An investor should invest in securities which are negatively correlated or unrelated so that the decrease in price of one security can be compensated by the increase in price of other security.


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Capital Structure & the Cost of Capital

from Finance 101: Principles of Finance

Chapter 15 / Lesson 1
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