Which of the following statements is CORRECT?
A) An investor can eliminate virtually all market risk if he or she holds a large and well diversified portfolio of stocks.
B) The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
C) It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
D) Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
E) An investor can eliminate virtually all diversifiable risk if he or she holds a large, well diversified portfolio of stocks.

Question

Quizplus · Accepted Answer

Diversifiable risk, also known as unsystematic risk, can be eliminated by holding a well-diversified portfolio of stocks. This is because unsystematic risk is the risk that is specific to a particular company or industry and can be reduced through diversification. However, market risk, also known as systematic risk, cannot be diversified away and affects the entire market. Therefore, statement A and C are incorrect. The higher the correlation between stocks in a portfolio, the higher the risk inherent in the portfolio, making statement B incorrect. As for statement D, adding additional stocks to a portfolio can still provide benefits in reducing unsystematic risk, although the benefits start to decrease as the number of stocks in the portfolio gets larger.

Which of the Following Statements Is CORRECT