The creation of a portfolio by combining two assets having perfectly positively correlated returns cannot reduce the portfolio's overall risk below the risk of the least risky asset, whereas a portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components.

Question

Quizplus · Accepted Answer

This statement is true. When two assets have perfectly positively correlated returns, they move in tandem and do not provide any diversification benefits. Therefore, creating a portfolio combining these two assets cannot reduce overall risk below the risk of the least risky asset. On the other hand, when two assets have less than perfect positive correlation, they move independently of each other and can provide diversification benefits, which can reduce total portfolio risk to a level below that of either of the components.

The Creation of a Portfolio by Combining Two Assets Having