You currently own Cavanaugh Inc. and are thinking of adding either Coe Co. or Firm Co. to your holdings. All three stocks offer the same expected return and total risk. The covariance of returns between Cavanaugh and Coe is +0.5 and the covariance between Cavanaugh and Firm Co. is "" 0.5. Portfolio's risk would:
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A. B. C. D.Explanation
In portfolio composition questions return and standard deviation are the key variables. Here you are told that both returns and standard deviations are equal. Thus, you just want to pick the companies with the lowest covariance, because that would mean you picked the ones with the lowest correlation coefficient.= [++
2where==so you want to pick the lowest covariance which is between Cavanaugh and Firm.