1.Analyze the relationship between risk and rate of return, and suggest how you would formulate a portfolio that will minimize risk and maximize rate of return.
The relationship between risk and rate of return is risk determines expected rates of return on every existing asset investment. The Risk-Return relationship is characterized as being a "positive" or "direct" relationship. (Importance of risk relationship , 2001). In other worlds if the risk of investing on an investment is high then the return will also be high.. Alternatively, if an investment has relatively lower levels of expected risk then the investor will get relatively lower returns. The risk and rate of return relationship effects both business managers and individual investors. The higher the chance of risk the more likely it must be compensated with higher return. “Since investment returns reflects the degree of risk involved with the investment, investors need to be able to determine how much of a return is appropriate for a given level of risk.”(Importance of risk relationship, 2001). In other words the risk for investment returns needs to be determined before the investment is carried out so that the investor knows what level of risk they are at. This process is called “pricing the risk". The price of risk is defined as the measure of risk quantified to determine how much risk is appropriate to bear for the investment. (Importance of risk relationship, 2001). When formulating a portfolio with minimal risk and maximum return, one must quantify the degree of risk they are willing to take towards the investment. One must also pick an investment that does not have much risk involved. For instance if they choose to invest in a rental property then the chances of risk are not as high as opposed to if the person invested in a restaurant. If the restaurant becomes a flop and has to shut down the owner would loose more money because it costs more to keep a restaurant. The chances of a real estate rental property becoming a loss are less because people always need a place to live. If the investor was unable to rent the property then he or she can always sell it. It would be easier to sell a rental property then it is to sell a commercial property such as a restaurant. Thus knowing the type of investment it is lets the person determine the degree of risk involved. Therefore to maximize risk and minimize one must pick a sound money making investment that does not involve much risk in the first place. 2. Formulate an argument for investment diversification in an investor portfolio. An investor should have a diverse portfolio because the diversification of portfolios lets the investor know which companies are best to invest in? Which companies have a better economic outlook in the future? Having a diverse portfolio also makes a investor a more round up individual. They gain more knowledge of where to invest their money and which investment has a higher return rather then risk. A person should also have a diverse portfolio because one never knows which asset will have a higher value over time. The highest returning asset will usually be the most risky one, so the chances of loss are greater, too. (Reilly, 2012). There are also time factors to take into consideration when deciding to hold an asset. Shares are the best performing asset over the long-term, but not always in the short term. A bear market in shares can savage your returns and your net worth. Another factor as to why one should have a diversified portfolio is because one never knows how their attitude will be towards the stock market, until the person has experienced it hitting their investment. 3. Address how stocks, bonds, real estate, metals, and global funds may be used in a diversified portfolio. Provide evidence in support of your argument.
There are two types of diversifications...