Question

Portfolio managers pick stocks for their clients’ portfolios based on the investment objective of the portfolio and several other factors. One key consideration is each stock’s contribution to portfolio risk and its statistical relationship with the portfolio’s other stocks. Based on your understanding of portfolio risk, identify whether each statement is true or false.

Answer 1

• False

• True

• True

• False

Step-by-step explanation:

First one is false because diversification reduces risk because it divides the risk amongst different securities. The portfolio risk will therefore be lower than the average of all stocks' standard deviations.

Second one is true because unsystematic risk is risk that will come with the type of stock or security purchased. It is usually referred to as diversifiable risk because using negatively correlated stocks can help diversify this risk.

Third one is True because the portfolio's risk when diversified is indeed likely to be smaller than the average of all stocks' standard deviation.

Fourth one is false because portfolio risk is reduced if stock that are negatively correlated are put into a portfolio because it means that when one stock is not doing so well, the other being negatively correlated, will be doing fine.