Sample Solution

Diversification is the process of allocating capital in away that reduces the exposure to anyone particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in variety of assets. It helps to avoid disasters investment outcome.This approach helps to reduce the risk without necessarily decreasing the expected rate of return which means it provides equivalent expected return with lower over all volatility.
Equally weighted portfolio return and randomly selected security returns are the same but with standard deviation is far lesser in an equally weighted portfolio.This is due to the portfolio correlation and interaction between different securities in the portfolio.

Diversification Ratio = Standard Deviation of Equally weighted portfolio /
Standard deviation of randomly Selected Security

Portfolio help to avoid the effect of downside risk associated with investing in a single security .
Selection of optimal portfolio are done by examining additional combination the same set of shares in different proportions and then observe the risk return trade -off for each of those combinations and then select the portfolio based on the best combination of the risk and return.

However, Portfolio diversification not necessarily offers down side protection because in diversification approach the decision is based on co-movements, and co- relations that is derived out of the past data and these historical co-movements patterns are bound to change and also in times of severe market turmoil the investor does not experience the expected risk return projected through diversification approach.

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