Explain the following statement: The stand-alone risk of an individual corporate project may be quite high, but viewed in the context of its effect on stockholders’ risk, the project’s true risk may not be very large. How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?

Even if a project carries a high risk, the total effect on the corporation's risk depends on the relative weight or size of the project. E.g. Google invests billions in many extremely risky projects, and most of them fail terribly, but if you consider the overall weight of these projects on Google's total activities, it is really small. Therefore, the negative effects associated with these projects will be very small.

On a similar manner to a stock portfolio, a diversity of projects reduces risk. Sometimes corporations engage in riskier projects that have a negative correlation to the other projects carried out by the corporation in order to decrease overall risk. E.g. a corporation that invests in gold mines while its main projects are related to oil production. When the economy is doing well, the gold mines will not do very well, but any losses will be offset by the other oil investments. But if the economy enters a recession, then oil related investments will perform poorly, but gold mines will do great. IT might not be enough to offset the losses generated by oil projects, but at least they will be reduced.

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