Asked by Juanita Soriano on Jun 11, 2024
Verified
Which of the following statements is correct?
A) A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
B) Company-specific (or diversifiable) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk.
C) A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a one-stock portfolio if that one stock has a beta less than 1.0.
D) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
Company-Specific Risk
Risk that affects a particular company due to factors such as management decisions, product demand, or regulatory changes.
Diversified Portfolios
Investment strategies that involve spreading investments across various financial instruments, industries, and other categories to reduce risk.
Market Risk
The risk of losses in investments due to factors that affect the entire market or asset class, such as economic downturns or political instability.
- Comprehend the difference between unsystematic (diversifiable) risk and systematic (non-diversifiable) risk.
Verified Answer
MC
Meghan CooperJun 13, 2024
Final Answer :
B
Explanation :
Company-specific (or diversifiable) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk. This means that no matter how many stocks are added to a portfolio, it will still be subject to market risk. Additionally, statement A is incorrect as a larger portfolio does not always result in a lower standard deviation of returns, especially if the stocks in the portfolio are positively correlated. Statement C is also incorrect as a one-stock portfolio will always have a higher standard deviation of returns than a well-diversified portfolio, regardless of the beta of the single stock. Finally, statement D is incorrect as it is impossible to completely eliminate market risk from a portfolio.
Learning Objectives
- Comprehend the difference between unsystematic (diversifiable) risk and systematic (non-diversifiable) risk.