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Question (Relevant to the Series 65, and Series 66):
A portfolio manager is constructing a portfolio of two stocks, and wants the stocks to be as uncorrelated as possible. Which of the following correlation values is best suited to the manager’s goals?
Answers:
A. -1
B. -0.5
C. 0.1
D. 1
Correct Answer: C. 0.1
Rationale: Correlation measures the relative movement of two stocks, and is represented by values between -1 and 1. At 1, the stocks are perfectly correlated, meaning if the first stock increases by a certain percentage, the other stock increases by the exact same percentage. At -1, if the first stock increases by a certain percentage, the other decreases by that same percentage. At 0, there is no correlation, meaning stocks move independent of each other. The portfolio manager is seeking to have very little correlation, where 0 would be ideal. Since 0 is not one of the answers, we need to find the answer closest to zero, which is 0.1.
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