Which of the following statements is most correct concerning diversification and

Question

Which of the following statements is most correct concerning diversification and risk?

a. Risk-averse investors often select portfolios that include only companies from the
same industry group because the familiarity reduces the risk.
b. Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry.
c. Only wealthy investors can diversify their portfolios because a portfolio must contain at least 50 stocks to gain the benefits of diversification.
d. Proper diversification generally results in the elimination of risk.

You are considering buying some stock in Continental Grain. Which of the following
are examples of non-diversifiable risks?

I. Risk resulting from a general decline in the stock market.
II. Risk resulting from a possible increase in income taxes.
III. Risk resulting from an explosion in a grain elevator owned by Continental.
IV. Risk resulting from a pending lawsuit against Continental.

a. III and IV
b. II, III, and IV
c. I and II
d. I only

In 1998 Fischer Corp. issued bonds with an 8 percent coupon rate and a $1,000
face value. The bonds mature on March 1, 2023. If an investor purchased one of
these bonds on March 1, 2008, determine the yield to maturity if the investor paid
$1,050 for the bond.

a. 8.5%
b. The yield to maturity must be greater than 8% because the price paid for the bond
exceeds the face value.
c. The yield to maturity is $950 ($1,000 interest less $50 capital loss).
d. 7.44%

Explanation / Answer

B. Diversification reduces risk C. I and II are general risks that are non specific to Continental D. Since the amount paid was greater than the face value, the yield to maturity (expressed as a percentage) must be less than the coupon rate.

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