Strategy Beginner: The Importance of Diversification

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1.
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.
2.
Financial advisors suggest diversifying because putting your money into different investments is often the best way to avoid losing large sums of money.
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True. Diversifying spreads risk among several investments.
3.
Risk tolerance is the amount of risk with which you are comfortable.
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True. It determines your choices of investments, among many other things.
4.
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.
5.
The chance of experiencing inflation is an example of unsystematic risk.
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False. Inflation influences all companies as well as the entire economy. Diversification cannot eliminate the risk of facing inflation. Therefore, it is a systematic risk.
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.
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.