CS Executive · Corporate Accounting and Financial Management · Security Analysis
Two securities have a correlation coefficient of -1. Combining them in suitable proportions will, in theory:
Portfolio risk can be eliminated entirely. With a correlation of -1, the two securities move in exactly opposite directions, so at suitable weights their fluctuations cancel out and the portfolio standard deviation becomes zero. Risk equals the weighted average only at a correlation of +1.
- ALeave portfolio risk equal to the weighted average of their risks
- BIncrease portfolio risk above that of either security
- CEliminate portfolio risk entirelyCorrect
- DEliminate only systematic risk
Explanation
With perfect negative correlation, movements offset completely, so appropriate weights can bring portfolio standard deviation to zero. Option A describes a correlation of +1.
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