Question 8: Dudley Trudy, CFA, recently met with one of his clients. Trudy typically invests in a master list of 30 equities drawn from several industries. As 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.

1. Contrast the concepts of systematic risk and firm-specific risk, and give an example of each type of risk;

2. Analyze critically the clients suggestion. Discuss how both systematic and firm-specific risk change as the number of securities in a portfolio increases.