Question

QUESTION 1

Part A: Which of the following statements is CORRECT?

		a. An investor can eliminate virtually all stand-alone risk if he or she holds a very large and well diversified portfolio of stocks.
		b. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
		c. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
		d. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.
		e. It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. formuasheet.png

Part B:

Which of the following is incorrect?

		a. Add stocks with perfect correlation with each other will reduce the portfolio risk
		b. Combining 2 stocks that has a negative correlation with each other in a portfolio will reduce the portfolio risk.
		c. Combining 2 stocks that has a correlation of coefficient of 0.5 in a portfolio will reduce the portfolio risk.
		d. Add a stock that has the perfect correlation with the existing portfolio with each other will not reduce risk

Answer 1

Part A: The answer is "d"

Diversifiable risk means the unsystematic risk. Unsystematic risk can be eliminated when an investor a large portfolio of diversifiable stocks. So when the price of one stock will decrease the other stocks will rise and eliminate the fall in return of the portfolio.

Part B" The correct option is "A"

Adding stocks with a perfect portfolio will not reduce portfolio risk. As when one stock will fall the other stock will also fall. So if you add the stock with a perfectly negative correlation, then the risk will be eliminated.

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