Strategy Beginner: The Importance of Diversification

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1.
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.
2.
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.
3.
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.
4.
Diversifying across industries can reduce risk.
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True. Problems that befall one industry may not befall others.
5.
In investing language, what does it mean to diversify?
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To divide your investments among a variety of assets. This can mean different types of assets, different industries, different countries, etc.
6.
A fall in price of one security in a diversified portfolio may be offset by an increase in price of another.
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True. Problems in one industry may lead people to seek the products or services of another in your portfolio.
7.
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.