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) A portfolio with 10 randomly selected U.S. stocks
b) A portfolio with 10 randomly selected stocks from U.S. and international markets
c) A portfolio with 10 randomly selected international stocks

Answer 1

b) A Portfolio with 10 randomly selected stocks from U.S and international markets.

Step-by-step explanation:

Standard Deviation denotes risk of a stock. Standard deviation of a portfolio denotes the total risk of a portfolio comprising of different stocks.

The more diversified a portfolio is, the lesser would be the risk i.e standard deviation of the portfolio since stock price movements would be less related with one another. So if one stock falls, increase in another would offset the loss arising from the first.

In the given case, construction of a portfolio with 10 randomly selected stocks from U.S and international markets represent least correlation and hence more diversification.

And since the portfolio would be more diversified, the risk of such a portfolio i.e it's standard deviation would be comparatively less (smallest).