Hi all, I wonder if anyone can help me, I’m not sure of the logic of the answer to the following question so here it is… Given the following correlation matrix, a risk-averse investor would least prefer which of the following 2-stock portfolios (all else the same)? Stock A B C D A +1 B -0.2 +1 C +0.6 -0.1 +1 D +0.8 -0.3 +0.5 +1 A: A & C B: C & D C: B & C D: B & D Thanks!
That matrix is hard to read. But the answer should combine 2 stocks with most negative correlation. so i’d say B and D anser is D.
A. Pepp is right, but A/C has highest correlation. If A/D is one option, choose A/D.
Yeah I know sorry, it’s hard to replicate the matrix…I thought it would be answer C because stocks B & C have the least correlation creating the most diversification…? …and I just realised that I misread the question (even after posting it!!) and completely ignored the “least prefer”, these exams are obviously getting to me!
the question asks which portfolio he would least prefer, the answer is the one with the highest correlation (closest to 1)
HOLY crap. i better read the question next time CAREFULLY. why does cfa have to trick you with these “least, most, closest, two negatives, two positives words”
…and I just realised that I misread the question (even after posting it!!) and completely ignored the “least prefer”, these exams are obviously getting to me! I think I was too fixated on the Risk Averse Investor… It all makes sense now…cheers!!
D. D & B have correlation of -.3. offers the most diversification benefits. correlation ranges from -1 to +1. - 1 perfect negative correlation with the most benefits + 1 perfect positive corretaion no benefit Of all the numbers above -3. is closest to -1 so D is the best
what is the right answer here? A or D?
It’s Answer A. And if you could choose E: A&D You would choose E. Comprende?
In the matrix select the value closest to 1. This would be 0.8, which would be the correlation between A and D. Since A&D is not listed among choices, go with the second one, that would be 0.6, that’s A&C. Solution must be A.
Correlation= +1 the price of the two stocks “walk” together…like a nice couple Correlation= -1 each price of the two stocks “walk” by itself… (the couple break up)
I would say at 0.6 they are in trouble.
map1 Wrote: ------------------------------------------------------- > I would say at 0.6 they are in trouble. LOL 
They are in big trouble since the variability of one is only to be expressed by 36 % of the other.
cfaisok Wrote: ------------------------------------------------------- > They are in big trouble since the variability of > one is only to be expressed by 36 % of the other. Rule of thumb: if the correlations goes about 0.5, then walk away from her room very slowly and quitely…because there is high probability that she will shout!
