Total, nondiversifiable, and diversifiable risk

David Talbot randomly selected securities from all those listed on the
New York Stock Exchange for his portfolio. He began with a single
security and added securities one by one until a total of 20 securities
were held in the portfolio. After each security was added, David
calculated the portfolio standard deviation, kp.
The calculated values are shown in the following table.
a. On a set of number of securities in portfolio (x axis)portfolio risk
(y axis) axes, plot the portfolio risk data given in the preceding table.
b. Divide the total portfolio risk in the graph into its nondiversifiable
and diversifiable risk components and label each of these on the
graph.
c. Describe which of the two risk components is the relevant risk, and
explain why it is relevant. How much of this risk exists in David
Talbots portfolio?

16
14
12
10
8

Portfolio
Risk (%)

Limit
Value

4
2
0
0

9 10 11 12 13 14 15 16 17 18 19

c) According to EMH and CAPM, only nondiversifiable risk is relevant (up to the
limit value line). Diversifiable risk can be eliminated through holding a portfolio
of at least 20 securities which are not positively correlated. David Talbots
portfolio has 6,47% relevant risk.

19

Number of Se
Portfolio RisLimit value
0
1
14.5
6
2
13.3
6
3
12.2
6
4
11.2
6
5
10.3
6
6
9.5
6
Portfolio
7
8.8
6
Risk (%)
8
8.2
6
Limit 9
7.7
6
Value
10
7.3
6
11
7
6
12
6.8
6
13
6.7
6
14
6.65
6
15
6.6
6
16
6.56
6
17
6.52
6
18
6.5
6
19
6.48
6
20
6.47
6