Select all of the TRUE statements.

Question

BlackTom AI · Accepted Answer

Begin by outlining what the question is asking: identify all statements that are true among the given options.
Option 1: 'According to the mean-variance criterion, an investor will always prefer the portfolio with the highest expected return, regardless of volatility.' This is incorrect because the mean-variance framework evaluates portfolios based on both expected return and risk (volatility). An investor will not automatically prefer the highest return if it comes with disproportionately high risk; the trade-off between return and risk is central, typically via the efficient frontier and a chosen risk aversion.
Option 2: 'Systematic risk can be diversified away.' This is false. Systematic risk, also known as market risk, affects all assets and cannot be eliminated through diversification. Only idiosyncratic (unsystematic) risk can be reduced by holding a diversified portfolio.
Option 3: 'The variance of a portfolio always equals the average of the variances of the individual assets.' This is incorrect. The portfolio variance depends not only on the individual asset variances but also on covariances between asset returns. The formula includes weights, variances, and covariances, so the variance is not simply the average of the variances.
Option 4: 'More risk-averse investors choose portfolios farther from the risk-free point on the Capital Allocation Line.' This statement is misleading. On the Capital Allocation Line (CAL), moving away from the risk-free asset toward riskier portfolios increases expected return but also risk. A more risk-averse investor would typically choose portfolios closer to the risk-free point (lower risk), not farther away, so this statement is incorrect.
Option 5: 'Diversification can reduce idiosyncratic risk.' This is true. Idiosyncratic risk is the risk specific to individual assets, and it can be largely mitigated by holding a well-diversified portfolio, which averages out asset-specific fluctuations.
In summary, only Option 5 correctly states a true measure about diversification and risk, while Options 1–4 contain misunderstandings about risk-return trade-offs, diversification limits, portfolio variance, and CAL behavior.

COMM_V 371 101-107 2025W1 COMM 371 2025W1 Midterm - Nov 04 - Requires Respondus LockDown Browser

Select all of the TRUE statements.

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