Question

In: Finance

Which of the following is true concerning diversification? Assume that the securities being considered for selection...

Which of the following is true concerning diversification? Assume that the securities being considered for selection into a portfolio are not perfectly correlated.

Group of answer choices

The risk of the portfolio is certain to be increased as securities are added.

As more securities are added to the portfolio, the market risk of the portfolio declines.

After about 10 securities are added to the portfolio, additional securities have essentially no impact on reducing risk.

As more and more securities are added to the portfolio, the level of risk approaches the level of systematic risk in the market.

If you hold more than 100 securities, then the portfolio is risk-free.

Expert Solution

Answer:
As more and more securities are added to the portfolio, the level of risk approaches the level of systematic risk in the market.

Explanation:

As we add more and more securities we can kill the unsystematic risk and approach to the level of systematic risk in the market.

Systematic Risk/Non-diversifiable risk/Market risk:
1. Risk related to the economy.
2. Cannot be killed by diversification.

For Example:
1. Suppose a war is declared between two countries.
2. Government decisions / New political party coming into power.
3. Interest rate, Inflation fluctuation risk.

Idiosyncratic risk/ unsystematic risk/ diversifiable risk/ firm risk/ residual risk:
1. Risk arising from firms internal factors.
2. Can be killed by diversification.

Ex:
1. Losses caused by Labour strike/ Trade union.
2. Losses caused by fire breakout.
3. Losses caused by huge R&D failure.

The risk of the portfolio is certain to be increased as securities are added: False: when negatively correlated security are added the risk of the portfolio decreases.

Diversification means a reduction in the overall risk of the portfolio when 2 or more stocks are present in the portfolio. The overall risk of the portfolio is less than its weighted average risk of Individual stocks in the portfolio.

how can an investor have a diversified portfolio?

As per modern portfolio theory. There is a Benefit of diversification of risk when non-perfectly correlated stocks are added in the portfolio.

The benefit of diversification is when non perfectly correlated stocks are added then if the stock return of stock falls then it's offset by a rise in the stock return of another stock.

jeff jeffy answered 7 months ago

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