Portfolio Management - Portfolio Management Section 1

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8. Information about a portfolio that consist of two assets is provided below:

AssetPortfolio WeightStandard deviation
ABC30%10%
JKL 70%8%

  • Option : A
  • Explanation : Portfolio standard deviation = √((0.3)² (0.1)² + (0.7)² (0.08)² + 2 (0.8)(0.3)(0.7)(0.1)(0.08)) = 0.082 = 8.2%.
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9. Assume that two securities that are present in equal proportions in an investor’s portfolio have the same expected returns and volatility. For which of the following correlations between the two securities would the investor most likely be able to achieve the greatest diversification benefit?

  • 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  ABC
A. 1  
B. -11 
C.  0.5-0.51

  • 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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