It is often useful to know how well your portfolio is diversified. Two measures have been suggested:

a. The variance of the returns on a fully diversified portfolio as a proportion of the variance of returns on your portfolio.

b. The number of shares in a portfolio that (i) has the same risk as yours, (ii) is invested in “typical” shares, and (iii) has equal amounts invested in each share. Suppose that you hold eight stocks. All are fairly typical; they have a standard deviation of 40 percent a year and the correlation between each pair is .3. Of your fund, 20 percent is invested in one stock, 20 percent is invested in a second stock, and the remaining 60 percent is spread evenly over a further six stocks. Calculate each measure of portfolio diversification. What are the advantages and disadvantages of each?