Assume that the correlation coefficient ρA,B between the rates of return of stocks A and B...
Assume that the correlation coefficient ρA,B between the rates of return of stocks A and B is negative. Also assume that you combine the two assets to form portfolio P. All else equal, the higher the absolute value of ρA,B,
a.
sometimes the risk of P will be higher and sometimes lower
b.
the lower the risk of P
c.
the higher the risk of P
d.
cannot tell
Homework Answers
The coefficient of correlation represents the degree of relation between the return of two securities. A negative coefficient of correlation means that with increase in return on one security, return on other security will fall
A perfect negative correlation reflects lowest risk
Hence, the higher the absolute value of ρA,B
the lower the risk of P
The correct answer is b.
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