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

Question

Quizplus · Accepted Answer

Diversifiable risk, also known as unsystematic risk, can be eliminated through diversification. This means that by holding a large, well-diversified portfolio of stocks, an investor can eliminate most of the risk that is specific to individual companies (such as industry-specific risks or company-specific risks). However, market risk (also known as systematic risk) cannot be eliminated through diversification, as it is inherent in the overall market and affects all stocks. Therefore, choice E is incorrect. Choice A is also incorrect because while a high correlation between stocks does mean they move in the same direction, it does not necessarily mean the portfolio is less risky. Choice B is false because it is possible for a single stock to have less market risk than a portfolio that includes the stock if the portfolio includes other stocks with higher market risk. Finally, choice C is incorrect because adding additional stocks to a portfolio can still slightly reduce its risk even if it already includes 40 or more stocks.

Which of the Following Statements Is CORRECT