Question;-

"Your eccentric uncle died and left you $100,000. However, the will stipulated that the entire amount
must be invested in common stocks. Specifically, $50,000 must be invested in a single stock (a one-stock
portfolio) and the other $50,000 must be invested in a 100-stock portfolio. You are very risk averse, so
you want to minimize the riskiness of each $50,000 investment.
a. Describe the kind of stock you would choose for your single-stock portfolio?
Solution; -
If you invest that $50,000 in a single stock (one-stock portfolio) investment it means stock is held alone,
then the calculations of expected rate of return less and the standard deviation of returns is more then
we can treated as that stock is risky.
When higher the standard deviation it means more is the risk. But your objective is to minimize the
riskiness of the stock. In this case the investment should choose a stock which we are ready to invest in
single stock with the lowest standard deviation of returns and highest expected rate of return. That
particular stock will have the lowest risk.
b. What types of stock would you choose the stocks for your 100-stock portfolio?
Solution: - If you invest $50,000 in 100-stock portfolio, in such a case diversification effect comes in and
the risk is reduced through the correlation of returns between the stocks. Even the expected return and
standard deviation of the stock will be balanced or weighted if you put amount in more stocks as
portfolio.
Lower the correlation of returns between the stocks, lower is the risk of the portfolio. For a 100-stock
portfolio we should look for stock which has low correlation with each other.
This would maximize the effect of diversification and so increase the total returns without much
increase in risk
c. From a practical standpoint, how should you view the riskiness of your single-stock portfolio?
Solution: - In practical point of view we can judge the riskiness of the single stock portfolio based on
there past expected return and standard deviation risk, we can take over a period of time and analysis
with present expected return and standard deviation risk. So we can able to know that riskiness.
In normal case Diversification of risk in various stock will share the risk or balanced to risk in all stock but
in single stock we can not diversification so if loss occurs need bear all in single stock only