$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$\text { Investiment } A$ $ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$\text { Investment } B$
$\begin{array}{|l|l|l|l|l|}
\hline & \text { Good year } & \text { Bad year } & \text { Good year } & \text { Bad year } \
\hline \text { Probability } & 0.80 & 0.2 & 0.90 & 0.1 \
\hline \text { Pay-off } & 140 & 45 & 110 & 70 \
\hline
\end{array}$
-Once a portfolio becomes sufficiently large,the __________ is of greatest importance with respect to risk.

Question

$  \quad $$  \quad $$  \quad $$  \quad $$  \quad $$  \quad $$  \quad $$  \quad $$  \quad $$\text { Investiment } A$   $  \quad $$  \quad $$  \quad $$  \quad $$  \quad $$\text { Investment } B$
$\begin{array}{|l|l|l|l|l|}
\hline & \text { Good year } & \text { Bad year } & \text { Good year } & \text { Bad year } \
\hline \text { Probability } & 0.80 & 0.2 & 0.90 & 0.1 \
\hline \text { Pay-off } & 140 & 45 & 110 & 70 \
\hline
\end{array}$
-Once a portfolio becomes sufficiently large,the __________ is of greatest importance with respect to risk.

Quizplus · Accepted Answer

Once a portfolio of risky assets becomes sufficiently large,the individual asset variance has little effect on portfolio variance.It is the covariance between asset returns that takes on greater importance.This is a particularly useful characteristic when it comes to selecting assets for a portfolio.Although an asset may be exceedingly risky,having a very large variance of returns,its covariance with the assets in the portfolio may be such that including the asset in the portfolio reduces the variance of the portfolio as a whole.

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