Strategy Beginner: The Importance of Diversification

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1.
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.
Choose wisely. There is only one correct answer.
Negatively. Investments with prices that move opposite to each other are correlated negatively.
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.
A slump in one industry can actually help other industries.
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True. In industries that meet similar needs, people may use the products or services of another industry if their preferred one experiences major problems. For instance, if there are problems in the airline industry, transportation needs may be met by driving or using trains.
4.
Which of the following can reduce volatility in investing?
Choose wisely. There is only one correct answer.
Negative correlation of securities. A fall in one type of security can be offset by a rise in another.
5.
An investor can diversify by investing in different regions of the world.
Choose wisely. There is only one correct answer.
True. One can diversify in many ways. Choosing different regions is one way.
6.
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.
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.