CFA Level I · CFA Level I Exam · Portfolio Management: An Overview
An investor holds a single stock and adds a second stock whose returns are imperfectly correlated with the first. Which risk is most likely reduced by this addition?
Company-specific risk is most likely reduced. Adding an imperfectly correlated asset lets firm-specific shocks partly offset each other, whereas systematic, market-wide risks such as inflation affect all holdings and remain after diversification.
- ASystematic risk
- BCompany-specific riskCorrect
- CInflation risk of the whole market
Explanation
Combining assets with imperfect correlation lets idiosyncratic (company-specific) movements offset each other. Systematic risk affects all assets and cannot be removed by diversification, so options A and C are wrong.
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