Which of the following statements is not true regarding diversification? A well-diversified portfolio should earn the...

Which of the following statements is not true regarding diversification?

		A well-diversified portfolio should earn the risk-free rate of return
		A well-diversified portfolio’s risk can be measured by beta
		A well-diversified portfolio has only market risk
		A well-diversified portfolio has no unique risk
		A well-diversified portfolio has stocks whose returns are not perfectly correlated

Solutions

Expert Solution

There are two kinds of risks, systematic and unsystematic risk. Systematic risk cannot be diversified away and therefore is the risk faced by the entire market. Unsystematic risk is the risk which is firm specific and can be diversified.

Therefore if the portfolio is well diversified, then it should only have the systematic risk.

A well-diversified portfolio’s risk can be measured by beta because beta is the measure of systematic risk while standard deviation is that of total risk including unsystematic risk. So this statement is true because when there is no unsystematic risk, the total risk and the systematic risk are the same.
A well-diversified portfolio has only market risk: This statement is also true based on the above explanation
A well-diversified portfolio has no unique risk: Unique risk is the same as the firm specific risk so a well diversified portfolio doesn't have it so this statement is also true
To diversify a portfolio, uncorrelated assets are put together or less correlated assets are put together. So this statement is true too.

A well diversified portfolio can have a higher return it is only the risk that is reduced return may even increase, it cant be told based on this information. So this statement is false.

jeff jeffy answered 1 year ago

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