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(4.37) a mutual-fund company's newsletter says, a well-diversified portfolio includes assets with low correlations. the newsletter includes a table of correlations between the returns on various class
(4.37) a mutual-fund company's newsletter says, a well-diversified portfolio includes assets with low correlations. the newsletter includes a table of correlations between the returns on various classes of investments. for example, the correlation between municipal bonds and large-cap stocks is 0.50, and the correlation between municipal bonds and small-cap stocks is 0.21. step 1 of 2: rachel invests heavily in municipal bonds. she wants to diversify by adding an investment whose returns do not closely follow the returns on her bonds. should she choose large-cap stocks or small-cap stocks for this purpose? explain your answer. large-cap stocks; since the correlation of 0.50 indicates that ½ of the time large-cap stocks track the performance of municipal bonds and ½ of the time they do not. small cap stocks; since the correlation 0.21 indicates that 21% of the time small-cap stocks track the performance of municipal bonds and the remaining time they do not. small cap stocks; since the correlation 0.21, which is close to zero-indicates that the performances of small-cap stocks and municipal bonds do not track each other. large cap stocks; since any correlation that is less than 1 indicates that the performances are unrelated; i.e. the returns on large-cap stocks and municipal bonds do not track each other.
