Which one of the following statements is true regarding the variance of risky portfolios?
A) the higher the correlation coefficient between securities, the greater will be the reduction in the portfolio variance
B) there is a direct relationship between the securities correlation coefficient and the portfolio variance
C) the degree to which the portfolio variance is reduced depends on the degree of correlation between securities
D) proper diversification can reduce or eliminate all of a portfolio's risk

Question

Quizplus · Accepted Answer

The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. This is because when securities are positively correlated, their returns move in the same direction, resulting in higher portfolio risk. However, when securities are negatively correlated or have low correlation, their returns move in opposite directions, resulting in lower portfolio risk. Proper diversification can reduce portfolio risk, but it cannot eliminate all risk. Therefore, options A, B, and D are incorrect.

Which One of the Following Statements Is True Regarding the Variance