Question

Question 1 1 pts Select the statement below that is correct: After a portfolio has about 20 stocks, adding additional stocks will not reduce its risk at all. The higher the correlation between the stocks in a portfolio, the lower risk inherent in the portfolio. An investor can eliminate almost all diversifiable risk if they hold a large well-diversified portfolio of stocks. An investor can eliminate almost all non-diversifiable risk if they hold a large well-diversified portfolio of stocks. An investor can eliminate all risk if they hold a large and well diversified portfolio of stocks.

Answer 1

Correct answer is 3rd one.

An investor can eliminate almost all diversifiable risk if they hold a large well- diversified portfolio of stocks.

Unsystematic or diversifiable risk is firm specific risk. The internal factors such as management, labour conditions, efficiency, governance etc which are well within the control of the firm. The internal factors influences the returns of particular security. Unsystematic risk can be reduced by diversification..The basic idea here is DONOT PUT ALL YOUR EGGS IN ONE BASKET.

Other options are incorrect as-

Even after portfolio of 20 stocks, a stock of which risk is lower it will reduce the portfolio risk by small amount.

If the correlation between the stocks and portfolio is higher, there will be high risk in the portfolio. With increase in risk of stock the portfolio risk will increase.

Non diversificable risk cannot be diversified away by holding a large number of securities.

An investor cannot eliminate all risk, he can eliminate only diversifiable risk by holding a diversified portfolio.

Hope it helps!