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**CFA Practice Question**

Your portfolio consists entirely of stock A as of now. You are thinking of adding either stock B or stock C to your portfolio, both of which have the same mean and standard deviation of returns as A. The covariance between the returns on stocks A and B is 5.6 while that between A and C is -3.9. Then, which of the following is true about your portfolio risk?

A. It will increase if you purchased stock B OR A.

B. It will decrease more if B is purchased.

C. It will decrease more if C is purchased.

**Explanation:**Since the mean and standard deviations are equal, risk is reduced more when C is purchased since it is negatively correlated with A. Note that risk will reduce even if B is purchased.

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**User Contributed Comments**
4

User |
Comment |
---|---|

Kuki |
adding more stocks to your portfolio will reduce portfolio risk anyway. Here we need to find out which stock will reduce the risk more. |

azramirza |
Why B also?? Then it shd be A as well...?? |

chandsingh |
Question asks for which will reduce risk more |

Ifi2703 |
B reduces risk just because you have added more stock to the portfolio (like Kuki said). But the added factor of C being negatively correlated means they move in opposite directions and risk is reduced as losses in A will be balanced with gains in C and vice versa. So that's why C would reduce your risk more than B. |