No benefits of diversification with two stocks occur when is:
A) 0
B) 1
C) -1
D) 0.52

Question

No benefits of diversification with two stocks occur when  is:
A) 0 
B) 1 
C) -1 
D) 0.52

Quizplus · Accepted Answer

The coefficient of correlation between the two stocks (11ea8229_348f_a3a8_bbd8_a79f72a9c7aa_TB1726_11) is the determinant of whether diversification benefits exist or not. A coefficient of -1 indicates perfect negative correlation (i.e., the prices of the two stocks move exact opposite of each other) and provides perfect diversification benefits. A coefficient of 1 indicates perfect positive correlation (i.e., the prices of the two stocks move exactly in the same direction) and provides no diversification benefits. A coefficient of 0 indicates no correlation and provides the maximum diversification benefits. In this case, we do not know the coefficient of correlation between the two stocks, but we know that there are no diversification benefits, which means that the coefficient of correlation must be either 1 or very close to 1 (i.e., 0.52 is not a possible answer). Therefore, the best choice is B (1).

No Benefits of Diversification with Two Stocks Occur When