Strategy Beginner: The Importance of Diversification

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1.
An investor can diversify by investing in different regions of the world.
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True. One can diversify in many ways. Choosing different regions is one way.
2.
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.
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.
What are the two most basic types of risk?
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Systematic and unsystematic. All other types of risk fall into these two categories.
5.
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.
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.
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.