The following relate to modern investment theory:
1. Discuss whether each of the following statements are true or false, and provide justification.
(a) A good way to reduce risk is to buy investments that have a high standard deviation of returns’. Comment.
(b) With the right sort of diversification, a portfolio of investments can achieve an expected rate of return that is higher than the highest rate of return expected from any of its individual component investments.
(c) With the wrong sort of diversification, a portfolio of investments might have an expected standard deviation of its rates of return that is higher than the highest standard deviation of returns expected from its individual, component investments.
(d) When the correlation coefficient between two risky investments’ rates of return is positive, the size of the portfolios expected standard deviation of returns will be somewhere between the two standard deviations of the individual component assets. Consequently, the only risk reduction achieved by diversifying cross these two investments is simply through an averaging of the two standard deviations.