Strategy Beginner: The Importance of Diversification

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1.
The risk of the company in which you invest being destroyed by a passing tornado is an example of _______ risk.
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Unsystematic. A tornado is a natural disaster that is unlikely to affect all industries; hence, it is an unsystematic risk.
2.
When a financial advisor says, "Let's talk about risk and how much you can deal with," he or she is talking about _______.
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Risk tolerance. Risk tolerance is the amount of risk with which you are comfortable.
3.
Investment portfolios can be called efficient when they ________.
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Contain the best possible mixes of assets for a specific risk level and return. Efficiency is relative to the kind of objective that you are trying to fulfill.
4.
Diversification helps to reduce risk because _______.
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Different investments perform differently. The idea behind diversification is that the changes in differently performing investments will cancel each other out.
5.
Diversifying your stock portfolio among different companies or _______ can reduce risks that are specific to a company.
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Industries. Sometimes, a problem that hits one company in an industry can hit others in that industry.
6.
You have invested in a portfolio that has only two stocks. You observe that every time one stock goes up in price, the other goes down. The two stocks are _______ correlated.
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Negatively. Investments with prices that move opposite to each other are correlated negatively.
7.
Which of the following can reduce volatility in investing?
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Negative correlation of securities. A fall in one type of security can be offset by a rise in another.