Combining two assets having perfectly negatively correlated returns will result in the creation of aportfolio with an overall risk that
A) decreases to a level below that of either asset.
B) increases to a level above that of either asset.
C) stabilizes to a level between the asset with the higher risk and the asset with the lower risk.
D) remains unchanged.

Question

Quizplus · Accepted Answer

When two assets have perfectly negatively correlated returns, this means that when one asset's return is high, the other's return will be low, and vice versa. By combining these two assets, the portfolio's overall return will be the average of the two assets' returns. However, due to the perfect negative correlation, the portfolio's overall risk will be lower than either individual asset's risk. This is because the assets' risks offset each other, resulting in a diversified portfolio with a lower overall risk. Therefore, choice A is correct, as combining two negatively correlated assets results in a portfolio with decreased overall risk.

Combining Two Assets Having Perfectly Negatively Correlated Returns Will Result