WHICH OF THE FOLLOWING IS FALSE CONCERNING DIVERSIFICATION? ASSUME THAT THE SECU

Question

WHICH OF THE FOLLOWING IS FALSE CONCERNING DIVERSIFICATION? ASSUME THAT THE SECURITIES BEING CONSIDERED FOR SELECTION INTO A PORTFOLIO ARE NOT PERFECTLY CORRELATED. SELECT ONE: A. AS MORE SECURITIES ARE ADDED TO THE PORTFOLIO, THE PORTFOLIO RISK EVENTUALLY APPROACHES THE LEVEL OF SYSTEMATIC RISK IN THE MARKET. B. IF YOU HOLD MORE THAN 100 SECURITIES THEN THERE IS LITTLE BENEFIT TO BE GAINED BY ADDING A 101ST SECURITY TO THE PORTFOLIO. C. AS MORE SECURITIES ARE ADDED TO THE PORTFOLIO, THE TOTAL RISK OF THE PORTFOLIO DECLINES. D. AS MORE SECURITIES ARE ADDED TO THE PORTFOLIO, THE SYSTEMATIC RISK OF THE PORTFOLIO DECLINES. E.AS MORE SECURITIES ARE ADDED TO THE PORTFOLIO, THE UNSYSTEMATIC RISK OF THE PORTFOLIO DECLINES.

Explanation / Answer

D is a false statement, since Systematic Risk cannot be diversified away. Adding securities to a portfolio is aimed at reducing unsystemtic risk. Since it is assumed that the securities in the portfolio are not perfectly correlated, it would reduce unsystematic risk through diversification to a particular point betyond which no further diversification benefits can be achieved.

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