Explanation:
The correct answer is A.
According to modern portfolio theory and the Capital Asset Pricing Model (CAPM), holding the market portfolio is advisable because it is perfectly diversified and only carries systematic (market) risk, for which investors earn a risk premium. Individual stocks contain both systematic risk and idiosyncratic (firm-specific) risk. Since idiosyncratic risk can be freely diversified away, the market does not compensate investors with an additional risk premium for bearing it. Therefore, an asset owner holding individual stocks takes on extra, uncompensated risk compared to holding the market portfolio.
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Q.3017 Which of the following reasons best explains why it is advisable for asset owners to hold the market portfolio as compared to individual stocks?
A
The individual stocks are not only exposed to the market factor which carries the risk premium, but they also have idiosyncratic risk.
B
Individual stocks represent a systemic risk, and it is not passive since all risky assets have risk premiums that are only determined by their exposure to the market portfolio.
C
The market portfolio is not held by every investor, which has a strong implication that is not outright rejected in the data.
D
It can not be determined
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