- Option : A
- Explanation : Higher correlations will result in a lower diversification benefit and higher volatility.

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- Option : C
- Explanation : 10% = w¡* 16 % + (1 – w¡)* 6%;
w¡ = 40%, (1 – w¡) = 60%.

Thus, 40 percent should be invested in the small-cap fund and 60 percent should be invested in the bond fund.

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- Option : B
- Explanation : Diversification benefit is greatest when a portfolio consists of securities that do not move together and thus the investor should invest in securities with the lowest correlation i.e. – 0.86.

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10. A correlation matrix of the returns for securities A, B, and C is reported below:

Security | A | B | C |

A. | 1 | ||

B. | -1 | 1 | |

C. | 0.5 | -0.5 | 1 |

- Option : A
- Explanation : The negative correlation of –1.0 between investment instruments A and B is lowest and therefore is most effective for portfolio diversification.

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