1. Which statement about portfolio diversification is correct?

a. Proper diversification can reduce or eliminate systematic risk.

b. The risk-reducing benefits of diversification do not occur meaningfully until at least 15-20 individual securities have been purchased.

c. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return.

d. Typically, as more securities are added to a portfolio, total risk would be expected to fall at a decreasing rate.

2. You have found a stock with a beta lower than any other stock in your portfolio. This stock also has a very high return. However, the stock has a history of high variability of returns. If you do not want to increase the risk of your portfolio, are you interested in this stock?

a. Yes, because a low beta will lower the portfolio beta (i.e., risk), and the other variability (variance) specific to this stock will be diversified away. The most likely outcome will be a higher return and lower portfolio variance.

b. No, because the high variability of returns would increase my portfolio variance.

c. Uncertain, because I would have to weigh the higher return against the higher portfolio variance.

d. No, because a lower beta would cause my portfolio to be more defensive, an undesirable result even given a higher return.