Diversification A popular theory in investment states that you should invest a certain amount of…

Diversification A popular theory in investment states that you should invest a certain amount of money in foreign investments to reduce your risk. The risk of a portfolio is defined as the standard deviation of the rate of return. Refer to the graph in the next column, which depicts the relation between risk (standard deviation of rate of return) and reward (mean rate of return).

(a) Determine the average annual return and level of risk in a portfolio that is 10% foreign.

(b) Determine the percentage that should be invested in foreign stocks to best minimize risk.

(c) Why do you think risk initially decreases as the percent of foreign investments increases?

(d) A portfolio that is 30% foreign and 70% American has a mean rate of return of about 15.8%, with a standard deviation of 14.3%. According to Chebyshev’s Inequality, at least 75% of returns will be between what values? According to Chebyshev’s Inequality, at least 88.9% of returns will be between what two values? Should an investor be surprised if she has a negative rate of return? Why?

 

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