An analyst has made the following return projections for each of three possible outcomes with an equal likelihood of occurrence:
Asset Outcome 1
(%) Outcome 2
(%) Outcome 3
(%) Expected Return
(%)
1 12 0 6 6
2 12 6 0 6
3 0 6 12 6
Q. Which pair of assets is perfectly negatively correlated?
- Asset 1 and Asset 2.
- Asset 1 and Asset 3.
- Asset 2 and Asset 3.
Solution
C is correct. Asset 2 and Asset 3 have returns that are the same for Outcome 2, but the exact opposite returns for Outcome 1 and Outcome 3; therefore, because they move in opposite directions at the same magnitude, they are perfectly negatively correlated.
why not asset 1 & 2 is negatively correlated
.