Question

In: Finance

Portfolio diversification eliminates which one of the following?

Portfolio diversification eliminates which one of the following?    

Group of answer choices

Market risk

Total investment risk

Reward for bearing risk

Portfolio risk premium

Security risk

Solutions

Expert Solution

Option E is correct: Security risk

Portfolio diversification eliminates security risk. Holding a large number of stocks in the portfolio eliminates firm-specific risk also called security risk. In other words, the security risk is diversified away in a diversified portfolio.

Option A is incorrect because the market risk cannot be eliminated with a diversified portfolio

Option B is incorrect because The total investment risk consists of market risk and security risk. The portfolio diversification does not eliminate market risk.

Option C is incorrect because Portfolio diversification lowers the reward, but it doesn't completely eliminate the reward for bearing risk

Option D is incorrect because portfolio risk premium (rm - rf) still exists in a diversified portfolio because of the market risk


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