- CFA Exams
- CFA Level I Exam
- Study Session 18. Portfolio Management (1)
- Reading 52. Portfolio Risk and Return: Part I
- Subject 5. Portfolio Risk

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**CFA Practice Question**

Security A has an expected return of 18% and a standard deviation of 40%. Securities B and C each have expected returns of 12% and standard deviations of 20%. If the correlation between the rates of return for A and B is 0.35, and for A and C is 0.85, then investors holding only A ______

A. who want to reduce risk would be better off adding B to their portfolios.

B. who want to reduce risk would be better off adding C to their portfolios.

C. would need to know the correlation between the rates of return for B and C to determine which security offers the best opportunity for risk reduction.

**Explanation:**Since B and C have the same expected return and standard deviation, the lower correlation of A and B will provide portfolios with superior opportunities to reduce risk.

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**User Contributed Comments**
6

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

murli |
Adding the assets with lower correlation will reduce the risk of portfolio. |

chuong |
Lower coeffiriennt correlation -> lower covariance - > lower Portfolio variance |

Criticull |
it's not negative, but something is better than nothing. |

MattNYC |
In large portfolios one does not need not to know the correlation but the AVG. COV between securities, since Portfolio size > Corr = Avg. Cov. |

Mhmdjamal |
same SD of both securities B&C,does it mean they perfectly correlated? |

Pusgkin94 |
Why not C? |