Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium, which of the following statements is CORRECT?
A) The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk.
B) Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios.
C) If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's.
D) The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.
E) Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.

Question

Quizplus · Accepted Answer

B) Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios if they have the same beta. This is because diversifiable risk can be reduced by increasing the number of stocks in the portfolio, but market risk, which affects all stocks, remains the same regardless of the number of stocks in the portfolio. The required return is determined by the market risk (beta), not by the diversifiable risk.

Ann Has a Portfolio of 20 Average Stocks, and Tom