Assume you are considering combining two investments to form a portfolio and you are very concerned with the risk that will result from the combination. If you want to attain the greatest effect from diversification, you would prefer that the assets _____.
A) are negatively related
B) are positively related
C) are not related
D) have a negative coefficient of variation
E) have a positive coefficient of variation

Question

Quizplus · Accepted Answer

When assets are negatively related, they have a low or negative correlation coefficient, meaning their returns move in opposite directions. By combining two negatively related assets, the portfolio's risk can be reduced through diversification. Therefore, a portfolio that combines negatively related assets will result in the greatest effect from diversification, which is what the investor is looking for.

Assume You Are Considering Combining Two Investments to Form a Portfolio