FIN630 GDB solution

Suppose two securities have perfect negative correlation. Would it make sense to invest in these two securities only? Briefly explain your answer

Idea Solution:-

Negative, indicating that the returns on the two securities tend to move inversely;when one increases (decreases), the other tends to decrease (increase), When the covariance is negative, the correlation coefficient will also be negative. 

For example, if you think the market is going to go up, you may invest $150 of the $200 in the first stock and only $50 in the second stock. Thus if the stock goes up 30% your $150 investment is worth (150*1.3) = $195 and your other investment is worth $50*(.7) = $35. Thus overall you have $230 which is an overall gain. 

NOTE: You have assumed risk here. in Positive correlation securities the securities moves in same direction means profit in one security and also in second security and when securities going downs both are in same direction risk of loss but in negative correlation if one security going up and other security is going down. So risk is less and investor may invest in this security..

 

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