If two investments are perfectly negatively correlated:
A) diversification is not effective at reducing risk.
B) bets are perfectly hedged and risks are canceled out.
C) diversification reduces risk without changing the expected payoff.
D) diversification reduces both risk and the expected payoff.

Question

Quizplus · Accepted Answer

If two investments are perfectly negatively correlated, it means that one investment's gain is exactly offset by the other investment's loss. Therefore, the bets are perfectly hedged and risks are canceled out, making diversification not effective at reducing risk. However, the expected payoff is also reduced to zero.

If Two Investments Are Perfectly Negatively Correlated