Which of the following statements is correct?
A)A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
B)Company-specific (or diversifiable) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk.
C)A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a one-stock portfolio if that one stock has a beta less than 1.0.
D)If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

Question

Quizplus · Accepted Answer

Company-specific (or diversifiable) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk. This means that no matter how many stocks are added to a portfolio, it will still be subject to market risk. Additionally, statement A is incorrect as a larger portfolio does not always result in a lower standard deviation of returns, especially if the stocks in the portfolio are positively correlated. Statement C is also incorrect as a one-stock portfolio will always have a higher standard deviation of returns than a well-diversified portfolio, regardless of the beta of the single stock. Finally, statement D is incorrect as it is impossible to completely eliminate market risk from a portfolio.

Which of the Following Statements Is Correct