Which of the following statements is CORRECT? Group of answer choices An investor can eliminate almost...

Which of the following statements is CORRECT?

Group of answer choices

An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.

An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks.

An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.

Solutions

Expert Solution

The correct statement is -

-> An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

Unsystematic or or diversifiable risk is firm specific risk. The internal factors such as management, labour conditions, efficiency, governance etc which are well within the control of the firm. The internal factors influences the returns of particular security. Unsystematic risk can be reduced if the investor holds a very large, well-diversified portfolio of unrelated stocks. The basic idea here is DONOT PUT ALL YOUR EGGS IN ONE BASKET. This will lead to risk reduction.

Other options are incorrect as -

Systematic risk is risk that varies with changes in the economic, social, cultural changes on which the firm has no control.The external factors influences the returns of all securities in the market. It is non diversificable risk.It cannot be diversified away by holding a large number of securities.

--> Hence, investor cannot elimitate market risk.

Total risk = Systematic risk (non-diversifiable risk ) + Unsystematic or diversifiable risk

-->Systematic risk cannot be reduced to 0, hence investor cannot eliminate all risk.

--> The higher the correlation between the stocks in a portfolio, the higher the risk inherent in the portfolio. As higher correlated stocks will move in the same direction and hence the risk will be more.

Hope it helps!

jeff jeffy answered 2 years ago

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