NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Investments
Which of the following best describes the effect of diversification across assets that are not perfectly positively correlated?
Diversification across imperfectly correlated assets reduces unsystematic risk, which is specific to individual companies or sectors. It cannot remove systematic market risk, which affects all assets, and it does not raise the returns of each holding.
- AIt removes all market risk from the portfolio
- BIt reduces unsystematic risk of the portfolioCorrect
- CIt increases the expected return of every asset
- DIt eliminates the need to monitor the portfolio
Explanation
Combining assets whose returns are not perfectly correlated lowers company-specific (unsystematic) risk. Systematic or market risk cannot be diversified away. Diversification does not raise the expected return of individual assets.
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