Strategy Beginner: The Importance of Diversification

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1.
How can you greatly reduce unsystematic risk?
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Diversify your investments among several companies. Unsystematic risks are specific to a company. You can reduce them greatly by investing in several companies.
2.
Diversification among asset classes can reduce the overall return of a portfolio because _______.
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Diversifying among different asset classes means including less-volatile assets that have lower expected earnings. Returns are averaged among all the securities in the portfolio.
3.
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.
4.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
5.
For a given investment return, there are optimal mixes of stocks, bonds, and cash that produce different returns with a minimum of risk.
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True. These portfolios are called "efficient." Their optimality has been demonstrated by analyzing returns over history.
6.
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.
7.
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.