All RE5 questions
Financial Products Apply knowledge of the financial products and services environment
An investor holds shares in a single mining company. Her adviser suggests spreading the money across 40 companies in different industries. Which risk will this reduce, and which will remain?
RE5 practice question with a worked answer. This is one of hundreds of FSCA RE5 questions in the RegulatoryExams question bank.
- a) It reduces the risk of a general market decline, but company-specific risk remains.
- b) It removes both company-specific risk and the risk of a general market decline.
- c) It reduces company-specific risk, but the risk of a general market decline remains.Correct
- d) It reduces inflation risk, but company-specific risk remains unchanged.
Why this is the answer
Diversification reduces unsystematic risk, the risk particular to one company or industry, because poor results in one holding are offset by others. It cannot remove systematic or market risk, which affects all shares together. Inflation risk depends on the return relative to price increases, not on the number of holdings.
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