Which of the following statements is true regarding a portfolio's diversification?
A) proper diversification can reduce or eliminate systematic risk
B) the risk-reducing benefits of diversification do not occur meaningfully until at least 16 or more securities have been added to the portfolio
C) because diversification reduces a portfolio's total risk, it must reduce the portfolio's expected return
D) as more securities are added to a portfolio, total risk would be expected to fall at a decreasing rate under normal conditions

Question

Quizplus · Accepted Answer

Diversification reduces unsystematic risk, which is the risk specific to individual investments. As more securities are added to a portfolio, the impact of adding each new security on the portfolio's total risk diminishes, leading to a decrease in total risk at a decreasing rate. Systematic risk, which affects the entire market, cannot be eliminated through diversification. The statement about needing at least 16 securities for meaningful diversification and the idea that diversification must reduce expected return are misconceptions.

Which of the Following Statements Is True Regarding a Portfolio's