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.
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. |