NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Modern Portfolio Theory
Two assets have standard deviations of 10% and 20%. Which correlation coefficient between them would give the greatest diversification benefit when combined in a portfolio?
A correlation of -0.8 gives the greatest diversification benefit. Portfolio variance decreases as correlation between assets decreases, and the lowest correlation among the choices is the most negative one. A correlation of +1 gives no risk reduction at all.
- A+1.0
- B+0.5
- C0
- D-0.8Correct
Explanation
Portfolio risk falls as correlation falls. At +1 there is no diversification benefit, and risk is the weighted average of the two standard deviations. A correlation of -0.8 is the lowest listed, so it reduces portfolio variance the most.
Did you get it right without looking?
One question tells you little. A timed set on Introduction to Modern Portfolio Theory shows your real accuracy, how long you take and where you lose marks.
More Introduction to Modern Portfolio Theory questions
- Mr. Iyer holds a portfolio with an expected return of 14%, a standard deviation of 18% and a beta of 1.2. The risk-free rate is 6%. What is …
- Two assets have equal weights of 50% each. Asset X has standard deviation 10% and Asset Y has standard deviation 20%. Their correlation is 0…
- Asset A has a weight of 60% and expected return of 15%; Asset B has a weight of 40% and expected return of 10%. Their standard deviations ar…
- Two securities have a correlation coefficient of -1 between their returns. What does combining them in suitable proportions achieve in a por…
- Under CAPM, the risk-free rate is 7%, the expected market return is 12% and a stock of Tata Motors-like profile has a beta of 1.4. What is t…
- Stock A and Stock B each have a standard deviation of 20%. A portfolio is made with 50% in each stock. If the correlation between them is +1…