A portfolio manager is considering adding another security to his portfolio. The correlations of the five alternatives available are listed below. Which security would enable the highest level of risk diversification?
A) 0.0
B) 0.25
C) -0.25
D) -0.75
E) 1.0

Question

Quizplus · Accepted Answer

A correlation of -0.75 indicates a high negative correlation between the new security and the other securities in the portfolio. As a result, adding this security would provide the highest level of risk diversification to the portfolio as it would help to reduce portfolio volatility and increase portfolio returns. An ideal portfolio consists of securities with low or negative correlations as it reduces overall portfolio risk.

A Portfolio Manager Is Considering Adding Another Security to His