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. On the other hand, 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 up and down together, and it is not possible to create a portfolio that has less risk than the least risky asset. However, when assets have less than perfect correlation, combining them in a portfolio can reduce overall risk by diversifying across different sources of risk. This is called diversification, which is a central principle of modern portfolio management.

The Creation of a Portfolio by Combining Two Assets Having