Question

A woman owns 42 shares of stock in the Mandra Corporation. She wants to invest more money in the stock market. Statistically speaking, which of the following investments will reduce her risk (variance) the most.

A) buying more stock in the Mandra Corporation (MC)

B) buying stock in the Altes Corporation, a company in the same industry whose stock returns have correlation with MC of 0.9

C) buying stocks in SevCorp a heavy manufacturing company whose stock returns have correlation with MC of 0.2

D.) buying stocks in Repos an automobile repssession company whose stock returns have correlation with MC of -0.

Answer 1

Answer: Option D.

Lower the correlation, lower will be the combined variance.

Options A) and B) are incorrect. Keeping investments in the same or similar industry keeps the risks at a similar level.

Option C) and D) are better options as the correlation between the stocks of that company and Mandra Corporation is low. Of the two options, option D gives the lowest correlation of 0. This means that the stock price of Repos has no correlation with the stock price of Mandra Corporation. This will help in reducing the risk the most.