Two assets have a coefficient of correlation of -.4. Asset A has a standard deviation of 20% and asset B has a standard deviation of 40%. Relative to holding a portfolio consisting of 100% of Asset B, what happens to risk if you combine these assets into a 50-50 weighted portfolio?
A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower risk.
D) Combining these assets will reduce risk.

Question

Quizplus · Accepted Answer

Combining assets with a negative coefficient of correlation reduces portfolio risk due to diversification benefits. The negative correlation means the assets' returns move in opposite directions, which can smooth out the overall portfolio's return volatility.

Two Assets Have a Coefficient of Correlation of -