BU283 Chapter Notes - Chapter 6: Systematic Risk, Capital Asset Pricing Model, Capital Asset
Document Summary
Diversification is the act of giving something variety. The use of diversification in the context of investing can reduce/manage the risk of a portfolio. The key to diversification is selecting stocks that are negatively correlated meaning that if one is going down, the other is likely to go up. This takes away from a loss, but also a gain. Total risk = non-diversifiable risk + diversifiable risk: non-diversifiable risk is also sometimes call market or systematic risk. Systematic risk includes things like war, oil price shocks, and surprises that are unpredictable but effect the economy as a whole and almost all stocks: diversifiable risk is also sometimes called firm-specific or unsystematic risk. Unsystematic risks include things like strikes, input price changes, loss of a major customer, etc. These events affect one firm or a few firms. Na ve diversification is not the best approach to the creation of a portfolio.
