Rule: Portfolio theory is concerned with construction of an investment portfolio that efficiently balances its risk with its rate of return. Risk is often reduced by diversification, the process of mixing investments of different or offsetting risks. The broad categories of risk are summarized in the following mnemonic to get us DUNS.
Diversifiable |
Unsystematic (non-market/firm-specific) |
Non-diversifiable |
Systematic (market) |
Choice "A" is correct. Non-diversifiable risk cannot be eliminated by the application of portfolio theory. Non-diversifiable risk is also referred to as market or systematic risk. Choice "d" is incorrect. Diversifiable risk can be eliminated through effective application of portfolio theory. Diversifiable risks are also termed non-market risk.
Choice "b" is incorrect. Diversifiable risk can be eliminated through effective application of portfolio theory. Diversifiable risks are also termed unsystematic risk.
Choice "c" is incorrect. Diversifiable risk can be eliminated through effective application of portfolio theory. Diversifiable risks are also termed firm-specific risk.
