Question

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?a. The expected return of your portfolio is likely to decline.b. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.c. Both the diversifiable risk and the market risk of your portfolio are likely to decline.d. The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.e. The diversifiable risk will remain the same, but the market risk will likely decline.

Answer 1

Answer: b. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

Explanation:

Diversifiable risk is a risk that a particular security has or which can be seen in a certain sector. Market risk occurs when there's possibility that a particular investor will make loss due to certain factors which affects the entire market.

In the above scenario, the most likely to occur will be that the diversifiable risk of the portfolio will likely decline, but the expected market risk should not change.

It should be noted that diversification won't eliminate market risk. When more stocks are added, this brings about decline in diversification risk but market risk won't change.