Question

Ceteris paribus, given the following correlation coefficients between pairs of stocks, a portfolio constructed from which pair will have the lowest standard deviation?

Correl (A,B) = -1, Correl (C,D) = 1, Correl (E,F) = 0.75, Correl (G,H) = -0.75, Correl(I,J) = -0.50.

	a.	Pair C,D
	b.	Pair I,J
	c.	Pair G,H
	d.	Pair A,B
	e.	Pair E,F

Answer 1

Correlation moves between "-1 to +1"

where Correlation is "-1" we can reduce risk to "zero"

where correlation is "-1<r<1", we can reduce the risk, but "not to Zero"

Where Correlation "+1", we can't reduce the risk through diversification and the risk in this will be the weighted average risk of securities in that portfolio.

Thus it is suggestable to invest in A,B as correlation is"-1", we can reduce risk to"Zero".