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18 Which of the following statements is most correct? The variance of a portfolio is a...

18

Which of the following statements is most correct?

The variance of a portfolio is a weighted average of asset variances.

The benefits of diversification are greatest when asset returns have zero correlations.

The market portfolio truly eliminates all unsystematic risk.

Beta is the measure of an asset’s unsystematic risk.

Solutions

Expert Solution

Correct Option : The market portfolio truly eliminates all unsystematic risk

Each option is explained in detail below:

Explanation:

Option 1: The variance of a portfolio is not the weighted average of asset variances - False

Varaince of the portfolio is given by:

σP2 = w22σ12 + w22*σ22 + 2*w1*w2*ρ*σ1*σ2

Clearly Variance of the portfolio is not weighted average of asset variances

Option 2: The benefits of diversification are greatest when asset returns have zero correlations - False

The benefits of diversification are greatest when asset return have negative correlations as it will reduce the overall variance and hence standard deviation

Option 3: The market portfolio truly eliminates all unsystematic risk. - True

Market portfolio consists of stocks from different industries and hence Market portfolio eliminates firm-specific risk or unsystematic risk

This statement is Correct

Option4: Beta is the measure of an asset’s unsystematic risk - False

Beta is a measure of market risk for a firm as it measures the volatility of a stock with respect to the market

jeff jeffy answered 4 months ago
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