Question

Which of the following statements is CORRECT?

a. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.
b. If a stock has a negative beta, its expected return must be negative.
c. If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is 1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
d. According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.
e. A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.

Answer 1

Answer: e. A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.

Explanation: Diversification is a key concept in finance. When you hold a well-diversified portfolio with a large number of stocks, you can reduce specific risk (also known as unsystematic risk) associated with individual stocks. The risk that can be diversified away is unsystematic risk. A beta of 0.5 indicates less sensitivity to market movements, which reduces market risk (systematic risk).

Answer 2

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