Question

if the returns between two assets are negatively correlated, then the standard deviation of a portfolio made up of the two assets is:

A) equal to a weighted average of the individual asset's standard deviations.

B) Less than the weighted average of the individual asset's standard deviations.

C) Greater than the weighted average of the individual asset's standard deviations.

Answer 1

The answer here would be:

Option B - that the standard deviation of portfolio of these two assets would be less than the weighted average of the individual asset's standard deviations.

Explanation

If the returns of the two assets are negatively correlated in such a case, the return of the two securities would move in opposite directions as and when there is any movement in the market. This will give us a diversification benefit and would save the portfolio investor from extreme volatility.

Numerically, the benefit of this negative correlation of these two assets would be that the standard deviation of the portfolio consisting of these two assets will always bear a less deviation than these two assets individually.

Please like the answer - if it was helpful, it always keeps me motivated.