Question

Total, nondiversifiable, and diversifiable risk David Talbot randomly selected securities from all those listed on the New York Stock Exchange for his portfolio. He began with a single security and added securities one by one until a total o 20 securities were held in the portfolio. After each security was added David calculated the portfolio standard deviation, ? The calculated values are shown in the following table: a. Plot the date from the table on a graph that has the number of securities on the x-axis and the portfolio standard deviation on the y-axis b. Divide the total portfolio risk in the graph intoits nondiversifiable and diversifiable risk components, and label each of these on the graph. c. Describe which of the two risk components is the relevant risk, and explain why it is relevant. How much of this risk exists in David Talbof's portfolio? t the best answer below.) iData Table (Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) 12 Number of Portfolio ? securities Portfolio risk, , 18.20% 16.50% 14.90% 13.30% 12.30% 11 .50% 10.70% 10.10% 9.30% 8.60% Number of securities risk, ?r 7 10% 7.10% 6.50% 6.00% 5 .70% 5.50% 5 .30% 5.25% 5.20% 5.15% Nondiversifiable Risk 12 13 14 15 16 Diversifiable Risk 15 20 10 Number of Securities in Portfolio O D 18 19 20

Answer 1

20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 1 0.00% Diversifiable risk (unsystematic risk Non-Diversifiable risk (Systematic risk) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Total portfolio risk = diversifiable risk + non-diversifiable risk

For question 1 and 2 refer to the chart

Question 3:

In this case, with increase in number of stocks, most of the individual stock risk has been diversified i.e. unsystematic risk has been covered to a greater extent.

Now, the risk which can't be covered and is still relevant to the portfolio is market risk or systematic risk or non-diversifiable risk. This risk depends on the macroeconomic conditions (such as political conditions, exchange rates, interest rate, etc.) and can't be covered through diversification