Question

Suppose there are two options to invest in stocks: Option 1: Invest in one single stock...

Suppose there are two options to invest in stocks:

Option 1: Invest in one single stock

Option 2: Invest in a portfolio consisting of different stocks

What kinds of risk you face for option 1 and options 2? Compare the risks of the two options.

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Answer #1

In option 1 we are facing two types of risk that is systematic risk and unsystematic risk. Systematic risk is occurs due to financial system where every stock is exposed to it. Unsystematic risk is specific risk or diversifiable risk which is stock specific.

In option 2 we have only systematic risk because unsystematic risk is removed by diversifying the risk of stocks by creating portfolio of different stocks.

In option 1 there is huge risk because if something wrong happens to company then stock price will fall very rapidly. But at the same time in case of option 2 it can be reduced by picking more stocks so that if any one stock performed bad then it can be average out by other stocks of the portfolio.

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