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Use your knowledge in this subject to explain why investors do not receive compensation for all...

Use your knowledge in this subject to explain why investors do not receive compensation for all the risks associated with an individual stock.

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Answer #1

The risk associated with an individual stock consists of unique or firm specific risk and market risk. Now we know that if we hold a portfolio with random stocks the firm specific risk can be eliminated completely hence firm specific risk is diversifiable. The other risk is market risk or systematic risk which is undiversifiable and all the firms in the market are exposed to this risk. Hence, the investor will receive compensation only for market risk and not for unique risk which can be diversified away at no cost.

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