Question

1. Explain the graph below.
   1. Talk about market risk, firm-specific risk, diversification and number of stocks in a portfolio
   2. Does that mean you need to buy at least 20 stocks? What are the possible scenario that someone is not diversified at all with more than 20 stocks in his/her portfolio?

Answer 1

A. Market Risk means all such uncontrollable risk which are related to macro conditions in the economy and these are the risk related to performing in the market and they can never be diversifiedb by proper diversification strategies. For example like change in the rate of interest

B. unsystematic risk are firm specific risk are also feature related to a specific firm and they can be eliminated through proper diversification strategies. For example employee problem in an organisation.

Diversification means allocation in various number of stock in order to eliminate the risk associated with investment into a single stock and it does not mean to add 20 stock in order to diversify because diversification can also be done with 5 stocks in different five sectors.

B. I do not think that I need to buy 20 stock to diversify and one can be diversified with 10 stocks or 15 stocks in its portfolio if his stocks are related to to exposure in various different sectors in order to eliminate the firm specific risk.