Security A's expected return is 10%, while the expected return of B is 14%. The standard deviation of A's returns is 5%, and it is 9% for B. An investor plans to invest equal amounts in A and B. Which of the following statements is true about this portfolio consisting of stock A and stock B?
A) The risk of the portfolio is equal to 7%.
B) The lower the correlation of returns between the two stocks, the higher the portfolio's risk.
C) The risk of the portfolio is primarily dependent on the utility function of the investor.
D) The higher the correlation of returns between the two stocks, the higher the portfolio's risk.

Question

Quizplus · Accepted Answer

The risk of the portfolio is dependent on the correlation between the two stocks. The higher the correlation of returns between the two stocks, the higher the portfolio's risk, as the stocks move closer together in price. Therefore, choice D is the correct answer. Choice A is incorrect as the risk is not equal to the standard deviation of either stock but is dependent on their correlation. Choice B is incorrect as lower correlation results in lower portfolio risk. Choice C is incorrect as the utility function of the investor has no bearing on the relationship between two stock prices.

Security A's Expected Return Is 10%, While the Expected Return