Assume two securities are negatively correlated.If these two securities are combined into an equally weighted portfolio,the portfolio standard deviation must be
A)equal to the standard deviation of the overall market.
B)equal to the arithmetic average of the standard deviations of the individual securities.
C)equal to zero.
D)less than the weighted average of the standard deviations of the individual securities.
E)equal to or greater than the lowest standard deviation of the two securities.

Question

Quizplus · Accepted Answer

When two securities are negatively correlated, their combination results in reduced portfolio risk. The portfolio standard deviation is a function of not only the individual standard deviations but also the correlation between the two securities. As the two securities are negatively correlated, their combination results in a lower portfolio standard deviation than the weighted average of the standard deviations of the individual securities. Therefore, the portfolio standard deviation must be less than the weighted average of the standard deviations of the individual securities. Choice D is the only option that captures this explanation.

Assume Two Securities Are Negatively Correlated