1. Why is diversification important? How is diversification achieved?

2. Solely on the basis of diversification, is there an argument for selling any of the stocks? In addition to risk reduction through diversification, you explain to Chris and Kate that stock prices generally move with the market but the amount of movement differs. This market risk cannot be diversified away, but investors can select securities based on their willingness to bear market risk. Beta coefficients, which are an index of the market risk, indicate this source of risk from a stock or a portfolio. You suggest that they obtain the beta coefficient for each stock, since they are readily available through the Internet (see Part 1 of Chris and Kates assignment for possible Web sites or the Internet Assignment in this chapter.) After obtaining the betas, Chris and Kate should answer the following questions.

3. What are the beta coefficients for each stock, and what do the betas imply about each stocks market risk?

4. What is the average beta of the ten stocks? What does this aggregate portfolio beta imply about the portfolios tendency to move with the market? Is the portfolio more risky than the market as a whole?

5. How has each stock performed since the assignment started? How much is the entire portfolio worth?

6. What was the change in the market since the assignment began? Did each stock follow the market? Did the stocks perform better or worse than the market? Were the percentage changes greater or smaller than the percentage change in the market? Is the portfolios performance better or worse after considering the portfolios market risk as indicated by the portfolio beta?

7. If an investor wanted to construct a well-diversified portfolio of stocks with moderate market risk, do these ten companies achieve that objective?

At the dinner table, Chris and Kate announce that their instructor informed them that they did not consider the risk associated with the stocks they selected. As an extra credit assignment, the instructor wants them to address risk. You know that any portfolio raises questions concerning risk and portfolio management. You explain to Chris and Kate that diversification requires that asset prices and returns not be related (the lower the correlation, the better). You suggest they approach the assignment by answering a series of questions.