Question

Diversification of a portfolio can increase your reward per unit of risk:

Select one:

a. If the returns of the securities are not perfectly positively correlated

b. Because you diversify away the unsystematic (unrewarded) risk

c. Both of the above

d. Neither of the above

Answer 1

The correct answer is "C"

If the securities are not perfectly positively correlated, then it means that if one security falls, the other securities will not fall by the same amount or may even rise if the correlation is negative. Due to diversification, the unsystematic risk, that is company-specific risk is wiped out and the investor is only left with systematic risk, investor is paid for the systematic risk only

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