LOS a: Explain the importance of the portfolio perspective.

Q1. Which one of the following alternatives correctly outlines the importance of the portfolio perspective?

A)   Market participants should attempt to eliminate the unsystematic risk associated with each security by forming portfolios that will diversify away this risk.

B)   Market participants should analyze the risk-return trade-off of a portfolio as a whole, not the risk-return trade-off of the individual investments in a portfolio.

C)   Market participants should focus on the systematic risk of the components of a portfolio not the unsystematic risk of the components of a portfolio.

Q2. Equity pricing models assume which risk is priced?

A)   Unsystematic.

B)   Both systematic and unsystematic.

C)   Systematic.

Q3. Diversification can reduce:

A)   systematic risk.

B)   macroeconomic risks.

C)   unsystematic risk.

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Q1. Which one of the following alternatives correctly outlines the importance of the portfolio perspective?

A)   Market participants should attempt to eliminate the unsystematic risk associated with each security by forming portfolios that will diversify away this risk.

B)   Market participants should analyze the risk-return trade-off of a portfolio as a whole, not the risk-return trade-off of the individual investments in a portfolio.

C)   Market participants should focus on the systematic risk of the components of a portfolio not the unsystematic risk of the components of a portfolio.

Correct answer is B)

The key underlying principle of the portfolio perspective is that market participants should analyze the risk-return trade-off of the portfolio as a whole, not the risk-return trade-off of the individual investments in the portfolio.

Q2. Equity pricing models assume which risk is priced?

A)   Unsystematic.

B)   Both systematic and unsystematic.

C)   Systematic.

Correct answer is C)

Unsystematic risk can be diversified away. Thus, equity-pricing models are designed to reflect only systematic risk. It is assumed that the portfolio manager will take steps to diversify and reduce risk.

Q3. Diversification can reduce:

A)   systematic risk.

B)   macroeconomic risks.

C)   unsystematic risk.

Correct answer is C)

Systematic risk reflects factors that have a general effect on the security markets as a whole, and cannot be diversified away. Macroeconomic risk comes in many forms, and it is usually considered systematic risk. Unsystematic risk can be reduced through diversification.