A financial planner is examining the portfolios held by several of her clients.

Question

A financial planner is examining the portfolios held by several of her clients. Which of the following portfolios is likely to have the smallest standard deviation? A portfolio consisting of about 30 energy stocks A portfolio containing only Chevron stock A portfolio consisting of about 30 randomly selected stocks Portfolio managers pick stocks for their clients' portfolios based on the investment objective of the portfolio and several other factors. One key consideration is each stock's contribution to portfolio risk and its statistical relationsh with the portfolio's other stocks. Based on your understanding of portfolio risk, identify whether each statement is true or false.

Explanation / Answer

(a) False. The portfolio's risk is the square root of weighted average of the individual stocks standard deviations.

(b) True. The portfolio's risk is likely to be smaller than the average of all stock's standard deviations. It is because of the effects of diversification.

(c) True. Portfolio risk will decline if more stocks that are negatively correlated with other stocks are added to the portfolio.It will reduce the risk amount.

(d) False. The market risk component of the total portfolio risk can be reduced by adding consistently many stock.

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