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Standard Deviation Correlation with Stock Average Return of Returns Stock A 6% 5.52% 0.75 9% 10.75% 0.3 8% 12% -0.4 Suppose y
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Answer #1

Answer: STOCK Z

The reason is that a stock with a negative correlation provides the highest diversification benefits beacuse of the offsetting effect that they adds on to the portfolio's returns. In a simple terms, a negative correlation stocks in a portfolio helps the one stock's negative return to get offsetted by a positive return of the other stock . This happens because both the stocks moves in the opposite direction with respect to the market movement, when the correlation is negative.

Therefore, due to a negative correlation, STOCK Z will provide highest diversification benefit.

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