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Assume N securities. The expected returns on all the securities are equal to 0.01 and the variances of their returns are all equal to 0.01. The covariances of the returns between two securities are all equal to 0.005.
I. What are the expected return and the variance of the return on an equally weighted portfolio of all N securities? Please, note that the variance is presented by the formula, which depends on N.
II. What value will the variance approach as N gets large?
From parts (i) and (ii): Can you conclude what characteristic of the securities is most important when determining the variance of a well-diversified portfolio?
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