Arizona State University (ASU) Fin300 Fundamentals of Finance Final Practice Exam

Portfolio risk refers to the risk associated with combining different assets in a financial portfolio. It encompasses the overall risk of an investment portfolio, which includes not only the individual risks of the assets themselves but also how these assets interact with each other in terms of their correlations.

When constructing a portfolio, the objective is often to diversify risk by including assets that respond differently to market conditions. For instance, when one asset may perform poorly, another might not be significantly affected or could even perform well, thereby balancing the overall risk within the portfolio.

Understanding portfolio risk is critical because it recognizes that the total risk of a portfolio is not just the sum of the risks of the individual assets. Instead, the portfolio's risk profile can shift depending on the asset correlation – lower correlations among assets typically lead to a reduction in overall portfolio risk. This concept emphasizes the significance of asset allocation and diversification in risk management strategies.