- CFA Exams
- CFA Level I Exam
- Topic 9. Portfolio Management
- Learning Module 63. Portfolio Risk and Return: Part II
- Subject 2. Pricing of Risk and Computation of Expected Return

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**CFA Practice Question**

You are considering a portfolio only of long positions not involving leverage and have the following information:

2 | 18% | 64 | R

3 | 24% | 400 | R

Stock | Expected Return | Variance | Correlation

1 | 15% | 100 | R

_{1,2}= 0.62 | 18% | 64 | R

_{1,3}= 0.23 | 24% | 400 | R

_{2,3}= -1.0Without doing any calculations, what is the correct statement about the risk of a portfolio consisting of these three stocks?

A. The portfolio standard deviation must be between 8% and 20%.

B. The portfolio standard deviation could be less than 8%.

C. The portfolio standard deviation could be larger than 20%.

**Explanation:**The portfolio's standard deviation could be less than the lowest individual security's standard deviation of 8% because the correlation coefficients are all less than +1.0.

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**User Contributed Comments**
5

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

tll936 |
don't understand, any one help? |

ninad123 |
If correlation coefficient less than 1 then if we add stock with correlation less than 1 to portfolio the risk i.e S.D. will keep on reducing. |

endurance |
the whole concept about MPT is about this question |

viruss |
it only means that even if you add securities that have higher standard deviations, you will reduce the risk of your portfolio (diversification concept). You then take the lowest standard deviation and you know that it could be lower ... |

farhan92 |
I used a calculator but the comment by endurance basically sums it up. |