1
Q
Diversification tries to remove what?
A
Firm-specific risk
2
Q
Portfolio return of two risky assets
A
r\p = w\d r\d + w\e r\e
3
Q
Variance of Rp
A
o^2\p = w^2\d o^2\d + w^2\e o^2\e + 2w\d w\e Cov(r\d, r\e)
4
Q
Covariance of returns on bonds and equity
A
Cov(r\d, r\e) = p\de o\d o\e
5
Q
What happens when p\de o\do\e = -1?
A
- Debt and equity are perfectly inversely related
- There is no diversification
- A perfect hedge is available
