An investor holds a equity portfolio consisting of thirty U.S. large-cap stocks broadly diversified across all major industry sectors. Expecting a broad macroeconomic slowdown that could depress equity prices across the entire stock market, the investor considers purchasing shares of twenty additional large-cap companies from distinct sectors to completely remove market risk. Which of the following statements correctly evaluates the outcome of this proposed strategy?
- Further diversification will reduce unsystematic risk, but it cannot eliminate market risk because systematic risk affects the broad market as a whole.Cevap
- BAdding twenty additional equities will completely eliminate market risk, provided the new holdings have a low correlation with the existing portfolio.
- CThe strategy fails because market risk is solely driven by issuer-specific default events rather than overall macroeconomic factors.
- DThe strategy will eliminate market risk by causing bond prices to rise automatically whenever prevailing interest rates increase.
Cevap
Further diversification will reduce unsystematic risk, but it cannot eliminate market risk because systematic risk affects the broad market as a whole.
Market risk is a systematic risk caused by macroeconomic factors affecting the broader financial market. While diversification effectively reduces unsystematic (specific) risk, it cannot eliminate systematic risk.
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Systematic Risk and Diversification Limits
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