Please discuss the following questions in details. 1) We have seen that in the l
ID: 2793447 • Letter: P
Question
Please discuss the following questions in details.
1) We have seen that in the long run stock investments have tended to substantially outperform bond investments. However, it is not all uncommon to observe investors with long horizons holding entirely bonds. Are such investor irrational?
2) What are the implications of the efficient markets hypothesis for investors who buy and sell stocks in an attempt to "beat the market"?
3) In broad terms, why is some risk diversifiable? Why are some risk nondiversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk?
Explanation / Answer
1)
No, because
stock investments are much riskier. Some of the investors are highly risk averse in their investments and the additional possible returns doesn't seems much attractive to the risk averse investors relative to the extra risk they bear.
2)
If we ignore the trading costs and other additional transaction expenses then on average such investors merely earn what the market offers to them, stock investments all have a zero NPV. If trading costs exist, then these investors lose by the amount of the costs. Hence basically the the costs offsets the benefits.
3)
Assets that are diversified have less risk these risks are called unsystematic risk. unsystematic risk can therefore be eliminated by diversifying the investment.Systematic risk affects all investments and can only be controlled by a reduction in the expected return. Because risk and return are directly propotional. In broader terms,with examples.
Economic crisis is one type of systematic risk which investor cannot control.
Unsystematic risk can be diversified by diversifying the portfolio that is by increasing the weight of risk free assets.