Asked by Colby Nuccio on Jun 18, 2024
Verified
Assume that you own a portfolio with a known average return and standard deviation. Which of the following stocks, if added to your portfolio, will not reduce its risk through diversification?
A) A stock whose return is negatively correlated with that of your portfolio and has a lower standard deviation.
B) A stock whose return is positively correlated with that of your portfolio and has a lower standard deviation.
C) A stock whose return is positively correlated with that of your portfolio and has a higher standard deviation than your stock.
D) All of the above will reduce the risk of your investment through diversification.
E) None of the above will reduce the risk of your investment through diversification.
Standard Deviation
A statistic that measures the dispersion or variability of a dataset relative to its mean.
Diversification
An investment strategy that reduces risk by allocating investments among various financial instruments, industries, or other categories.
Negatively Correlated
A relationship between two variables in which one variable increases as the other decreases.
- Understand the function of diversification in diminishing unsystematic risk.
- Acquire knowledge of portfolio theory principles and the correlation between risk and return.
Verified Answer
LL
Laila LohseJun 21, 2024
Final Answer :
C
Explanation :
Adding a stock that is positively correlated with your portfolio and has a higher standard deviation increases overall risk, not reducing it through diversification.
Learning Objectives
- Understand the function of diversification in diminishing unsystematic risk.
- Acquire knowledge of portfolio theory principles and the correlation between risk and return.