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Describe the portfolio approach to investing

Prerequisite None

43a. Portfolio Approach Portfolio Approach Portfolio Diversification Reduce Risk Composition Matters for Risk-Return Trade-off Not Necessarily Downside Protection Emergence of Modern Portfolio Theory

Diversification Ratio It is the ratio of the standard deviation of an equally weighted portfolio to the standard deviation of any of its constituent securitys.

p Diversification Ratio i

The lower the diversification ratio, the more diversified the portfolio This equally weighted portfolio is not necessarily the portfolio that gives the maximum diversification benefits

Question Which of the following is least likely to be true, regarding portfolio diversification ratio? A. Diversification ratio is calculated as the ratio of the risk of an equally weighted portfolio of n securities to the risk of single security selected at random from n securities. B. Diversification ratio provides a quick measure of the potential benefits of diversification; an equal-weighted portfolio is not necessarily the portfolio that provides the greatest reduction in risk. C. Portfolio diversification works best when financial markets are operating turmoil.

Solution C. Portfolio diversification works best when financial markets are operating turmoil.