CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II
In a well-diversified portfolio of equities, which type of risk is most likely to be reduced as additional securities with imperfectly correlated returns are added?
Nonsystematic risk is most likely reduced. It is specific to individual firms and tends to offset across many imperfectly correlated holdings, whereas market-wide risks such as economy-wide interest rate changes affect all securities and remain after diversification.
- AMarket risk
- BNonsystematic riskCorrect
- CInterest rate risk across the economy
Explanation
Nonsystematic (firm-specific) risk is idiosyncratic and is averaged out when imperfectly correlated securities are combined. Market risk and economy-wide interest rate risk are systematic and affect all securities, so diversification cannot remove them.
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