An investor is bullish on the technology sector and heavily invests in microchip companies. Impactful regulatory changes are announced that will negatively affect microchip manufacturing. In order to mitigate the risk to his portfolio, the investor should:

The investor's portfolio is heavily concentrated in a single industry (microchips), exposing it to significant non-systematic risk. The negative regulatory change is an example of this type of risk, as it specifically affects that industry. The most effective strategy to mitigate non-systematic risk is diversification. By purchasing assets that are uncorrelated with the technology sector, the investor can reduce the portfolio's overall volatility. Should the microchip stocks decline due to the new regulations, the performance of the uncorrelated assets would not be directly affected, thereby cushioning the portfolio's overall losses.

B. This action would increase concentration risk within the same negatively impacted industry, compounding the problem.
C. Selling unaffected holdings would further concentrate the portfolio in the at-risk microchip sector, increasing risk.
D. Buying more shares of the same affected companies increases exposure and concentration in the face of a known negative event.

1. FINRA Official Documentation. "Managing Investment Risk." FINRA.org. In the section "Diversification

" it states

"A diversified portfolio will have a variety of investments with different levels of risk. That way

if one of your investments is performing poorly

another may be doing well. This can help you manage the overall risk of your portfolio." The investor's portfolio lacks this variety.

Source: FINRA

"Managing Investment Risk

" available at https://www.finra.org/investors/learn-to-invest/key-investing-concepts/managing-investment-risk

2. University Courseware. Damodaran

A. (2022). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. New York University

Stern School of Business. In discussions on risk

Damodaran distinguishes between firm-specific (diversifiable) risk and market (non-diversifiable) risk. He notes

"The risk in an investment can be broken down into two components... The first is a firm-specific risk that can be reduced and perhaps even eliminated by diversifying across investments." The regulatory change is an industry-specific risk

which is a form of diversifiable risk.

Source: Chapter 4

"The Basics of Risk

" pages 61-63.

3. Peer-reviewed Academic Publication. Markowitz

H. (1952). "Portfolio Selection." The Journal of Finance

7(1)

77–91. This seminal paper introduces Modern Portfolio Theory

which mathematically demonstrates that combining assets with less than perfect positive correlation can reduce portfolio risk. The investor's action in option A directly applies this principle by adding uncorrelated assets to mitigate the specific risk of his concentrated holdings.

DOI: https://doi.org/10.2307/2975974 (Specifically

Section IV

pages 82-89

discusses the principle of diversification).