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Statement 1: If you can find two risky securities with a correlation of -1, theoretically you...

Statement 1: If you can find two risky securities with a correlation of -1, theoretically you can construct a risk-free portfolio using the two securities. Statement 2: Stocks A and B have returns that are independent of one another. (i.e., correlation coefficient  = zero.) There is no diversification benefit that can be achieved by combining A and B in a portfolio.

a. Only Statement 1 is correct.

b. Only Statement 2 is correct.

c. Both Statements are correct.

d. Neither Statement is correct.

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Answer #1

Correct option is (a) Only statement 1 is correct

Explanation:- When correlation between any two stocks is less than 1 then diversification benefit can be achieved after combining the two stocks. Therefore , when correlation is 0 then there will be diversification benefit.

When correlation between two stocks is -1 ,it means both are perfectly negatively correlated then standard deviation of portfolio is given by following formula :-

(Weight of stock A * Standard deviation of stock A)- (Weight of stock B * Standard deviation of stock B)

Hence ,if we will make Left hand side of minus sign = Right hand side of minus sign then we can achieve risk free portfolio.

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