Market prices, Valuation Principle, Net present Value, interest rates, Essay - 1

Market prices, Valuation Principle, Net present Value, interest rates, and bonds - Essay Example When a person decides to invest in the stock market the investor has to be willing to accept risk. Risk can be defined as the possibility that the actual return on an investment will be different than the expected return (Thefreedictionary, 2011). There are two types of risks: systematic and unsystematic risk. Systematic risk refers to risk that affects the entire marketplace, while unsystematic risk is risk that is related to a specific industry. Investors have to accept systematic risk because it cannot be manage by the investor. Unsystematic risk can be managed by the investor. For instance if the investor has a stock from an industry that faces major risks the investor can sell off that stock to eliminated the unsystematic risk. The expected return of a portfolio is the weighted average of the expected returns of the individual stocks in the portfolio. One would think based on that logic that the portfolio risk would be equal to the sum of the risk of the individual securities, b ut it is not. Typically the portfolio risk is smaller than the weighted average of the stock’s variances. Sometimes the risks of different stocks in a portfolio moved in opposite direction which canceled each other out forming a riskless portfolio. The measure of the degree of the relationship between the variables is called the correlation coefficient (Besley & Brigham, 2000).