ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Portfolio which consists of perfectly positive correlated assets having no effect of diversification. Diversification reduces the variability when the prices of individual assets are not perfectly correlated.

Detailed explanation-2: -A statistical measure of diversification is “correlation, ” which is measured on a scale that runs from-1.0 to +1.0. A correlation coefficient of-1.0 or +1.0 is considered perfect correlation, knowing how one series of data moves provides perfect information on how the second series will move.

Detailed explanation-3: -Statement I: When the two securities returns are perfectly positively correlated, the risk of their portfolio is just a weighted average of the individual risks of the securities. In such a case, diversification does not provide risk reduction but only risk averaging.

Detailed explanation-4: -If stocks were perfectly positively correlated, diversification would not reduce risk. True or False. Diversification over a large number of assets completely eliminates risk. False.

Detailed explanation-5: -Diversification works only when returns are uncorrelated. The risk of a diversified portfolio depends on the specific risk of the individual stocks. The risk that you can’t avoid no matter how much you diversify is known as market risk. For a well-diversified portfolio, only market risk matters.