The different between stated yield to maturity and realized yield to maturity are usually subject to reinvestment risk and default risk. For reinvestment risk, the stated yield to maturity of a coupon bond is realized only if the bond coupons are reinvested at the same rate as the promised yield. As zero coupon bonds provide no coupons to be reinvested, the final value of the investor’s proceed from the bond is independent of the rate at which coupons could be reinvested. There is no reinvestment rate uncertainty with zeros. For default risk, the stated yield to maturity will be realized only if the firm meets the obligations of the bond issue. For a default-free zero coupon, there is no any default risk. Therefore, the stated yield to maturity and realized yield to maturity of a default-free zero coupon bond will be always zero. Question 3
Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk. When investing, you will confront two main types of risk which are systematic risk and unsystematic risk. Only the unsystematic risk can be diversified. Let's say you have a portfolio of only airline stocks. If it is publicly announced that airline pilots are going on an indefinite strike, and that all flights are canceled, share prices of airline stocks will drop. Your portfolio will experience a noticeable drop in value. If, however, you counterbalanced the airline industry stocks with a couple of railway stocks, only part of your portfolio would be affected. In fact, there is a good chance that the railway stock prices would climb, as passengers turn to trains as an alternative form of transportation. But, you could...
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