Trent wants to form a portfolio of four different stocks. Summary data on the fo

Question

Trent wants to form a portfolio of four different stocks. Summary data on the four stocks appears below. The average standard deviation (found simply by summing the standard deviations and dividing by 4 which is the same as the weighted average in this example) across the four stocks is 17.25%. If Trent forms a portfolio by investing 25% of his money in each of the stocks in the table, it is very likely that the standard deviation of this portfolio’s return will be (more than, less than, equal to) 17.25%. Choose one of the options (more than, less than, equal to) and explain WHY? (Again, you are not asked to calculate portfolio standard deviation or correlation.)

Stocks# 1, 2, 3, 4

Return(%) 12, -4, 7, 3

Standard Deviation(%) 17, 29, 13, 10

Explanation / Answer

Average standard deviation of portfolio of four stck with equal weight is 17.25%. if four stock is selected for a portfolio then it will create diversification and investor get benefit of lower risk. Again if correlation between stock is lower then standard deviation of portfolio would also be lower than 17.25%.

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