A portfolio manager is assessing a client's existing portfolio, which has a standard deviation of 12% and generated an average annual return of 7% over the past three years. The client, a conservative high-net-worth individual, expresses concern about potential large fluctuations in her portfolio value. Which of the following statements best describes the meaning of standard deviation in this context?

Question: A portfolio manager is assessing a client's existing portfolio, which has a standard deviation of 12% and generated an average annual return of 7% over the past three years. The client, a conservative high-net-worth individual, expresses concern about potential large fluctuations in her portfolio value. Which of the following statements best describes the meaning of standard deviation in this context?

Answer options:

• Standard deviation measures the average annual return generated by the portfolio.
• Standard deviation quantifies the correlation of the portfolio's returns with the overall market. ✅ Standard deviation indicates the typical dispersion or volatility of the portfolio's returns around its average.
• Standard deviation represents the maximum possible loss the client could experience in a single year.

Correct answer: Standard deviation indicates the typical dispersion or volatility of the portfolio's returns around its average.

Explanation: Standard deviation is a statistical measure that quantifies the amount of variation or dispersion of a set of data values. In finance, it indicates the typical volatility of a portfolio's returns around its average return.