Question

Kara has a portfolio of 20 average stocks, and Drew has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is correct?

a) Kara's portfolio has lower risk due to diversification.
b) Drew's portfolio has lower risk due to diversification.
c) Both portfolios have equal risk.
d) The risk of a portfolio depends on the individual stock performance.

Answer 1

Kara's portfolio has lower risk than Drew's because it is better diversified with 20 stocks, reducing the impact of individual stock performance on overall risk.

Step-by-step explanation:

Kara's portfolio, with a larger number of stocks, is likely to have lower risk due to diversification. Diversification is a strategy that involves spreading investments across various assets to reduce the exposure to any single asset or risk. The more stocks in a portfolio, the more diversified it is, which typically reduces the portfolio's risk, as individual stock performance has less impact on the portfolio's overall performance.

In contrast, Drew's portfolio, with only 2 stocks, is less diversified and likely to have higher risk because it is more exposed to the performance of those individual stocks. Therefore, assuming the market is in equilibrium, the correct statement would be a) Kara's portfolio has lower risk due to diversification.