Questions on Investment - Essay Example

With the combination of these securities in the portfolio investors can minimize their risk without sacrificing their expected return. Ans 1b In table 1, we can see correlation coefficients of five different funds, if we want to invest in any of the two funds in the portfolio with minimum risk. For example Aviva Property and HSBC Asian Growth with correlation coefficient 0.10 can minimize the risk without sacrificing any of their expected return. In such a combination of these funds the risk will be diversified effectively without decreasing the level of expected return whatsoever.

Ans 1c We have a portfolio of two funds, Aviva property and HSBC Asian Growth. We have also combined other funds and analyzed their risk exposure and found that their portfolio has minimum levels of risk. This investor is investing 50% of the cash in both the funds minimizing its risk without change in the expected return. Aviva property has risk of 2.3% with negative return while HSBC shows 6.5% risk with a good level of return. If investors will invests separately in these funds, the risk will be more but in other combinations the risk will also be greater. Ans 1d i) As shown in figure 1, the curved line denoted with (a) is referred to as Efficient frontier while the straight line denoted by b is referred to as capital market line.

The other points mentioned in the figure are, D which is the risk free rate and C is the market portfolio. ii) When an investor has a portfolio at point E as shown in figure 1, where return is also decreasing but not that much with the risk. Every investor wants to hold the C point where only market risk is to be faced, but all the other risks are diversified and at point E the risk associated with the portfolio is high but both systematic and unsystematic risk are in its way. Only unsystematic risk is diversifiable but other risks can also be shown at beta. iii) Every investor tries to reduce the risk associated with its portfolio.

If the investor is willing to accept 10% of risk as shown in figure 1 it is difficult to get good results. As the risk is high and return is also high, this position becomes more sensitive to the market fluctuations. At this position a slight change in the market will affect the portfolio more. Investors can go for the risk free return but it is usually unrealistic as allowances for the differences in borrowing makes the model more complicated. Ans 2a In US-style option, the buyer has the right to exercise at any time before the expiry of the option and counterparty must follow in the part of the buyer of option for execution.

Counterparty doesn’t have any right to deny the execution of the option before the expiry of the risk associated with the counterparty. The reason for counterparty risk is basically due to the credit risk of the option writer (Klein and Yang 2010, p.1) Ans 2b The biggest advantage of using options contracts is that it gives stability and security to the investors and the traders. This makes them contribute more in the market operations and also greatly contribute to the economy. It reduces the risks involved and also increase investors confidence thus they buy more options the agents sells.

Since unsystematic risk is normally unverifiable, the risk occurs due to external factors which are unpredictable. In order to minimize