If the returns of two assets are perfectly positively correlated, an investor who puts half of his/her savings into each will:
A) reduce risk.
B) have a higher expected return.
C) not gain from diversification.
D) reduce risk but lower the expected return.

Question

Quizplus · Accepted Answer

If the returns of two assets are perfectly positively correlated, it means that they move up and down in unison. In this scenario, diversification does not reduce risk as both assets move together, and putting half of the savings into each asset will not reduce the overall risk. It also doesn't increase the expected return since the correlation between the assets is perfect, so the returns of both assets will be the same. Therefore, the investor does not gain from diversification in this case.

If the Returns of Two Assets Are Perfectly Positively Correlated