Which of the following statements concerning financial risk is false? Select one

Question

Which of the following statements concerning financial risk is false?

Select one:

a.

Generically, financial risk is related to the probability of a return that is less than expected.

b. If the returns on two investments move in unison (are perfectly positively correlated), combining the two into a portfolio will lower risk.

c. If the returns on two investments move in unison (are perfectly positively correlated), combining the two into a portfolio will not affect risk.

d. In the real world, it is not possible to create a riskless portfolio because all investment returns, to a greater or lesser extent, move with the overall economy.

e. Assume you know for certain that an investment will return negative 10 percent. (In other words, the probability of a negative 10 percent return is 100 percent.) Although the expected return is negative, the investment is riskless.

Explanation / Answer

Option B is correct

If two investments move in tandem with each other, making a portfolio out of them will not reduce the risk. It will just make the average of risks or probably increase the level of risk the portfolio has. This way, if we add them in an existing portfolio, it will not affect risk.

The risk reduces as the coefficient of correlation reduces. Adding negatively correlated stocks benefits the most in reducing portfolio risk.

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