You are comparing five separate portfolios comprised of two stocks each that have varying characteristics. Which...
You are comparing five separate portfolios comprised of two stocks each that have varying characteristics. Which characteristic is most indicative of a diversified portfolio?
a. The standard deviation of the portfolio equals the weighted average standard deviation of the two securities.
b. The correlation between the two securities is equal to zero.
c. The covariance of the two securities is equal to one.
d. There is a highly positive covariance between the two securities.
e. The correlation between the two securities is negative.
Homework Answers
A diversified portfolio is such that the returns of both do not move in the same direction so that the loss on one stock is offset by the profit on another stock.
Hence, there should be negative correlation between the securities
The correct answer is
e. The correlation between the two securities is negative.
0 correlation means no relation at all, standard deviation of portfolio should be less than the weighted average standard deviation
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