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Risk and Return

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The correlation between stocks A and B is 0.50, while the correlation between stocks A and C is -0.5. You already own stock A and are thinking of buying either stock B or stock C. If you want your portfolio to have the lowest possible risk, would you buy stock B or C? Would you expect the stock you choose to affect the return that you earn on your portfolio?

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Solution Summary

The solution discusses the effect of correlation on the portfolio returns.

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An investor aims at creating a portfolio of assets that will increase his returns while reducing his risk. The correlation of the assets held in the portfolio will affect the portfolio's risk.

Correlation is a statistical measure of how two securities move in relation to each other. Correlation is expressed by numbers ranging from -1 to +1. A value of +1 indicates a perfect positive linear relationship between the Assets in the portfolio. This means that the returns of the assets of the portfolio move together in a completely linear manner. A value of -1 indicates a perfect negative relationship between the ...

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