Copyright © 2006 Thomson Learning 27 The Basic Tools of Finance.

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Copyright © 2006 Thomson Learning 27 The Basic Tools of Finance

Figure 1 Risk Aversion Wealth 0 Utility Current wealth €1,000 gain €1,000 loss Utility loss from losing €1,000 Utility gain from winning €1,000 Copyright©2004 South-Western

Figure 2 Diversification Number of Stocks in Portfolio 49 (More risk) (Less risk) Risk (standard deviation of portfolio return) Aggregate risk Idiosyncratic risk 30 Copyright©2004 South-Western

Figure 3 The Trade-Off Between Risk and Return Risk (standard deviation) Return (percent per year) 50% stocks 25% stocks No stocks 100% stocks 75% stocks Copyright©2004 South-Western

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