CA Final · Advanced Financial Management · Portfolio Management
Which statement about diversification of a portfolio of equity shares is correct?
Diversification reduces unsystematic, company-specific risk, but systematic or market risk remains because it affects all securities together. Hence even a well-diversified portfolio still carries market risk, which is measured by beta.
- AAdding securities removes both systematic and unsystematic risk when the number of securities is large enough
- BUnsystematic risk can be reduced by diversification, while systematic risk remainsCorrect
- CSystematic risk is reduced by diversification, while unsystematic risk remains
- DDiversification has no effect on risk if the securities have positive expected returns
Explanation
Company-specific (unsystematic) risk is averaged out when imperfectly correlated securities are combined. Market-wide (systematic) risk affects all securities and cannot be diversified away. The option claiming both are removed is wrong because market risk persists.
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