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Maximum diversification benefit can be achieved if one were to form a portfolio of two stocks...

Maximum diversification benefit can be achieved if one were to form a portfolio of two stocks whose returns had a correlation coefficient of:

-1.0
+1.0
0.0
none of the above
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Answer #1

The correct answer is -1.0

Maximum benefit from diversification occurs when the correlation coefficient for pairs of stocks is minus one.

Diversification benefit - We should not invest our wealth in a single stock. We should invest in a portfolio. Whenever we combine two or more assets in a portfolio the risk gets reduced. The extent of risk reduction depends on correlation.
Correlation refers to the strength of liner relationship between two variables. It lies between -1 and +1. Lower the correlation, greater the benefit of diversification in the form of risk reduction. Therefore maximum benefit from diversification will occur when correlation coefficient is -1.

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