Explanation:
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Explanation
A
When
calculating
the
portfolio's
risk,
you
have
to
consider
the
effect
of
the
relationship
between
the
security
holdings
in
the
portfolio.
Thus,
it
cannot
be
calculated
simply
by
taking
the
weighted
average
of
the
individual
stocks'
standard
deviations.
The
portfolio's
risk
is
likely
to
be
smaller
than
the
average
of
all
stocks'
standard
deviations,
because
diversification
lowers
the
portfolio's
risk.
Correlation
is
defined
as
the
statistical
relationship
between
two
stocks.
If
two
stocks
move
in
the
same
direction,
they
are
referred
to
as
positively
correlated
stocks.
The
correlation
coefficient
(p)
measures
the
degree
to
which
two
stocks
are
correlated.
A
p
of
+1.00
between
the
two
means
that
both
stocks
will
move
in
the
exact
same
direction,
and
they
are
referred
to
as
perfectly
positively
correlated
stocks.
A
p
of
-1.00
between
the
two
means
that
both
stocks
will
move
in
the
exact
opposite
direction,
and
they
are
referred
to
as
perfectly
negatively
correlated
stocks.
A
p
of
0.00
means
that
returns
of
the
two
stocks
are not
related.
Portfolio
risk
consists
of
market
risk,
also
called
systematic
risk,
and
diversifiable
risk,
also
called
company-specific
risk
or
unsystematic
risk.
Diversifiable
risk
represents
the
risk
that
is
inherent
to
the
stocks
in
the
portfolio.
It
is
risk
associated
with
unexpected
events
that
affect
the
returns
associated
with
a
particular
stock.
Some
examples
include
lawsuits,
strikes,
or
product
failures.
Market
risk
refers
to
the
systematic
risks
in
the
equity
markets
that
are
affected
by
macroeconomic
conditions
and
external
factors.
Diversifiable,
or
unsystematic,
risk
can
be
reduced
by
adding
more
securities
to
the
portfolio.
However,
because
systematic
risk
is
associated
with
the
entire
market,
risk
can
be
reduced
by
investing
in
different
markets
through
a
process
called
hedging.