Which one of the following statements is correct concerning the standard deviation of a portfolio?
A) The greater the diversiﬁcation of a portfolio, the greater the standard deviation of that portfolio.
B) The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.
C) Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
D) Standard deviation measures only the systematic risk of a portfolio.
E) The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.

Question

Quizplus · Accepted Answer

The standard deviation of a portfolio can be lowered by changing the weights of the securities in the portfolio. This is because the standard deviation of a portfolio is affected not only by the standard deviation of each security held within the portfolio, but also by the correlation between those securities. By adjusting the weights of the securities in the portfolio, an investor can reduce the overall correlation and therefore lower the portfolio's standard deviation. The greater the diversification of a portfolio, the lower the standard deviation, not the greater. Standard deviation is not used to determine the amount of risk premium that should apply to a portfolio. Standard deviation measures both systematic and unsystematic risk, not just systematic risk. Finally, while the standard deviation of a portfolio is affected by the standard deviations of the individual securities held within it, it is not a simple weighted average of those standard deviations. The interplay between the securities and their correlations within the portfolio make the calculation more complicated.

Which One of the Following Statements Is Correct Concerning the Standard