c. Which of the following statements is/are correct (true/false)? 1. Diversifica
ID: 2820099 • Letter: C
Question
c. Which of the following statements is/are correct (true/false)? 1. Diversification reduces risk because prices of stocks do not usually move exactly together. 2. The risk that can be potentially eliminated by diversification is called market risk. 3. The risk of a well-diversified portfolio depends on the market risk of the securities included in the portfolio. 4. The sensitivity of an investment’s return to market movements is usually called its beta. 5. The expected return on a portfolio is a weighted average of the expected returns on the individual securities. 6. The standard deviation of returns on a portfolio is equal to the weighted average of the standard deviations on the individual securities if these returns are completely uncorrelated.
Explanation / Answer
Answer 1. Diversification reduces risk because prices of stocks do not usually move exactly together – TRUE stock does not have positive perfect correlation and hence diversification provide benefit of lower risk.
Answer 2. The risk that can be potentially eliminated by diversification is called market risk- FALSE risk that can be eliminated by diversification is called unsystematic risk and not market risk.
Answer 3 . The risk of a well-diversified portfolio depends on the market risk of the securities included in the portfolio- TRUE, diversification will eliminate unsystematic risk and what left will only be market risk or systematic risk.
Answer 4. The sensitivity of an investment’s return to market movements is usually called its beta- TRUE, beta measure the sensitivity of stock return to market return.
Answer 5 The expected return on a portfolio is a weighted average of the expected returns on the individual securities- TRUE, expected return is sum of weight * return of all securities.
Answer 6. The standard deviation of returns on a portfolio is equal to the weighted average of the standard deviations on the individual securities if these returns are completely uncorrelated. False, standard deviation of returns on a portfolio is equal to the weighted average of the standard deviations on the individual securities if these returns are completely correlated and not uncorrelated.
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