CMFAS M9A Risk Considerations of Structured Products question: the limits of diversification

CMFAS M9ARisk Considerations of Structured Products

Which statement about the limits of diversification is CORRECT?

A Diversification guarantees a positive return in every market condition over time
B An investor should always attempt to diversify away every last unit of risk
C Diversification is only ever needed within a single asset class, never across asset classes
D Removing every risk also removes expected return, so the aim is an acceptable level of risk

Show the answer and explanation

Answer: D. Removing every risk also removes expected return, so the aim is an acceptable level of risk

Diversifying away all risk removes the expected return with it; the objective is to manage risk down to an acceptable level, spanning both within and across asset classes, not to eliminate risk entirely.

Common mistake

Chasing zero risk also removes the reward — diversification manages risk rather than guaranteeing profit or eliminating risk.

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CMFAS M9A Risk Considerations of Structured Products question: the limits of diversification

Answer: D. Removing every risk also removes expected return, so the aim is an acceptable level of risk

Common mistake

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CMFAS M9A Risk Considerations of Structured Products question: the limits of diversification

Answer: D. Removing every risk also removes expected return, so the aim is an acceptable level of risk

Common mistake

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