Question

A financial planner is examining the portfolios held by several of her clients. Identify which of the following portfolios is likely to have the smallest standard deviation: H ILLBILL A portfolio with 10 randomly selected Canadian stocks only A portfolio with 10 randomly selected international stocks only A portfolio with 10 randomly selected stocks from Canadian and international markets B ESTE INTRE TINERET KEMEDEL S TARS YAYASANYA TUZO Portfolio managers pick stocks for their clients portfolios based on the investment objective of the client and several TRI other factors. One key consideration is each stock's contribution to portfolio risk and its statistical relationship with EFTER the portfolio's other stocks. Based on your understanding of portfolio risk, which of the following statements are true? Check all that apply. 5. Based on your understanding on l lowing state If more stocks that a 11th SUSIES The risk in a portfolio will increase if more stocks that are negatively correlated with other stocks are added to the portfolio when returns on Stock A increase, returns on Stock B also increase. In general, this would mean that Stocks A and B are positively corn ated. The portfolio's risk is not the weighted average of the individual stock's standard deviations, The market risk component of the total portfolio risk can be reduced by randomly adding stocks to the portfolio SRBIERI TES

Answer 1

Solution:-

Part I

Standard deviation of a portfolio is a measure of the portfolio's risk. We know that diversification in a portfolio reduces its risk. If the portfolio consists of only Canadian or international stocks, it would mean that the level of diversification would be lesser as compared to a portfolio invested in both Canadian and international stocks. Therefore, the portfolio with 10 randomly selected stocks from Canadian and international markets will have least amount of standard deviation and the correct option is the third option.

Part II

Option 1: When stocks that are negatively correlated are added to a portfolio, they together reduce the risk of portfolio by countering each others' risks and therefore, this option is not correct.

Option 2: When two stocks are positively correlated, it means that go in either direction together. So when one stock goes up, other stocks that are positively correlated to it go up as well. Therefore, this statement is correct.

Option 3: The portfolio's risk is not the weighted average of its standard deviations. This is because the portfolio risk depends not just on the individual risks of its constituent stocks but also the level of correlation among them. Therefore, this statement is correct.

Option 4: Market risk or systematic risk is the risk that the entire market is exposed to. Hence, adding stocks to a portfolio doesn't diversify or reduce the systematic risk as the whole economy is exposed to it. Hence, this statement is not correct.

Therefore, the correct options are options 2 and 3.