The correlation of Port. X’s returns and the mkt return is 0.95 and the correlqation of Port. Y’s return and the mkt return is 0.60. Which of the following statements best describes the level of port. diversificaion? A) Both X and Y are well diversified B) Both X and Y are poorly diversified C) X is well diversified and Y is poorly diversified D) X is poorly diversified and Y is well diversified
D or B.
I’d go with B. I wouldn’t define a .6 corr as ‘well diversified,’ but I’m not sure of the exact CFA #.
Perfectly Positively Co-related (+1) has no diversification benefits. So X (+0.95) is poorly diversified, Y is not doing good either (+0.6). So B and D have equal odds. I’ll go with B. But how do we truly segregate between “well” and “poor” context based verb-qualifiers used here? - Dinesh S
B. Both X &Y have pretty high correlations to the market.
D. 0.6 of correlation coefficient could results in significant reduction of unsystematic risk from a portfolio.
The perfectly diversified portfolio is the market; since X closely mimics it, X is certainly well diversified. So A or C. The subjectivity of well-vs-poorly diversified however renders this question crap. (Adding X to an existing portfolio may not diversify the existing portfolio very well. But it’s unclear what the question is trying to ask here.) Final answer: E. – crap question, move on.
Haha get ready to be shocked guys!!! Answer is C, with no reasoning provided. I’m quite sure it’s an error, but what about the dilemma b/w picking B or D. If one of them was <0.5, I would have gone with D, but still it’s a tough choice :S
Yup crap question it is… Hopefully the CFAI is done with these sort of retarded questions.
Maybe they are saying C because the market in itself is well diversified? I agree though… trashy question.
I would have gone with C. The correlation of the entire portfolio return is compared to Market return as a whole. If market goes down 100% Port X return would go down by 95%. For portfolio Y it would go down only by 60%. In real scenario, I doubt if you would have a portfolio which is in perfect negative correlation with market. Neither a portfolio that is indifferent to market.
apnesapne Wrote: ------------------------------------------------------- > In real scenario, I doubt if you would have a > portfolio which is in perfect negative correlation > with market. Short SPDR? > Neither a portfolio that is > indifferent to market. A bond?
Its obviously C… Whats not to understand… There is no unsystemetic risk in the market portfolio (completely diversified) and the portfolio with the highest correlation to the market is the portfolio that is the most diverse… At least thats the way I understand it, hope I am thinking correctly! haha…
C makes sense to me. you can not get more diversified than the market and 0.95 seems pretty good to me
chadtap Wrote: ------------------------------------------------------- > Its obviously C… > > Whats not to understand… There is no > unsystemetic risk in the market portfolio > (completely diversified) and the portfolio with > the highest correlation to the market is the > portfolio that is the most diverse… At least > thats the way I understand it, hope I am thinking > correctly! haha… Agree with you totally. The answer is C and it is definitely not a crap question