Dudley Trudy, CFA, recently met with one of his clients. Trudy typically invests in a master list of 30 equities drawn from several industries. As the meeting concluded, the client made the following statement: “I trust your stock-picking ability and believe that you should invest my funds in your five best ideas. Why invest in 30 companies when you obviously have stronger opinions on a few of them?” Trudy plans to respond to his client within the context of modern portfolio theory.a. Contrast the concepts of systematic risk and firm-specific risk, and give an example of each type of risk.b. Critique the client’s suggestion. Discuss how both systematic and firm-specific risk change as the number of securities in a portfolio is increased.
Dudley Trudy, CFA, recently met with one of his clients. Trudy typically invests in a master list of 30 equities drawn from several industries. As the meeting concluded, the client made the following statement: “I trust your stock-picking ability and believe that you should invest my funds in your five best ideas. Why invest in 30 companies when you obviously have stronger opinions on a few of them?” Trudy plans to respond to his client within the context of modern portfolio
theory.
a. Contrast the concepts of systematic risk and firm-specific risk, and give an example of each type of risk.
b. Critique the client’s suggestion. Discuss how both systematic and firm-specific risk change as the number of securities in a portfolio is increased.
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