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Unformatted text preview: isk factors that affect a large number of assets Also known as non­diversifiable risk or market risk Includes such things as changes in GDP, inflation, interest rates, etc. Unsystematic (Asset Specific) Risk Unsystematic (Asset Specific) Risk Risk factors that affect a limited number of assets Also known as unique risk and asset­specific risk Includes such things as labor strikes, part shortages, etc. Diversification Diversification Portfolio diversification is the investment in several different asset classes or sectors Diversification is not just holding a lot of assets Correlations among assets are important For example, if you own 50 internet stocks, you are not diversified (high correlation) However, if you own 50 stocks that span 20 different industries, then you are diversified (low correlation) Implications for Portfolio Implications for Portfolio Formation Combining assets together with low correlations reduces portfolio risk more The lower the correlation, the lower the portfolio standard deviation Negative correlation reduces portfolio risk greatly Combining two assets with perfect negative correlation reduces the portfolio standard deviation to nearly zero Diversifiable (unsystematic) Risk Diversifiable (unsystematic) Risk The risk that can be eliminated by combining assets into a portfolio Ofte...
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