Dudley Trudy, CFA, recently met with one of his clients. Trudy typically invests in a master list of 30 securities drawn from several industries. After 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 concept of systematic and firm-specific risk and give one example of each.
b. Critique the client's suggestion. Discuss the impact of the systematic risk and firm-specific risk on portfolio risk as the number of securities in a portfolio is increased.