NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Investments
Two stocks have equal expected returns and equal standard deviations. When combined in equal weights in a portfolio, the portfolio standard deviation will be LOWEST if the correlation between them is:
Portfolio risk is lowest when the correlation is -1. Perfectly negatively correlated assets move in opposite directions, so with equal weights and equal volatility the fluctuations cancel completely. Higher correlations offer less diversification, and at +1 there is no reduction in risk.
- A+1
- B+0.5
- C0
- D-1Correct
Explanation
Portfolio risk falls as correlation falls, because price movements offset each other. With equal weights and equal risk, a correlation of -1 makes the portfolio risk zero. At +1 there is no diversification benefit, and 0 or +0.5 give only partial reduction.
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