Question

If a stock portfolio is well diversified, then the portfolio variance:

a. will equal the variance of the most volatile stock in the portfolio.
b. may be less than the variance of the least risky stock in the portfolio.
c. must be equal to, or greater than the variance of the least risky stock in the portfolio.
d. is a weighted average of the variances of the individual securities in the portfolio. e. none of the above.

Answer 1

In a well-diversified stock portfolio, portfolio variance b)may be less than the variance of the least risky stock due to the risk offsetting effects of diversification.

Step-by-step explanation:

When considering a well-diversified stock portfolio, the portfolio variance may be less than the variance of the least risky stock in the portfolio. This phenomenon occurs because diversification can offset the risks of individual stocks in a way that the negative performance of some stocks is balanced by the positive performance of others. Hence, the combined effect could result in a total risk (variance) for the portfolio that is lower than even the least risky stock if only systematic risk remains, and unsystematic risks are diversified away.