A fund manager has diversified the equity portfolio he manages in order to reduce the potential negative impact of unfavorable information relating to any one stock. What type of risk has he reduced?
Unique risk, also known as firm-specific risk, is reduced through diversification, as it relates to volatility caused by information specific to individual securities. The feedback from the document states:
"If a security’s price is affected by new information, and if new information arrives frequently, then its price will tend to be volatile and so will the returns that it generates. This source of volatility is specific to a given security and is known as unique risk. Diversifying a portfolio reduces unique risk."
[Reference: Chapter 15 – Selecting a Mutual FundLearning Domain: Evaluating and Selecting Mutual Funds, , , , ]
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