What is the possible range for a correlation coefficient? For ...

[tiara099]

What is the possible range for a correlation coefficient? For purposes of diversification, what type of correlation coefficient among asset returns is preferred by investors? Explain why.
 
  What will be an ideal response?

Question 2

Define diversification. What are the benefits to diversification? Will diversification always lead to greater expected portfolio returns?
 
  What will be an ideal response?

[C.mcnichol98]

Answer to Question 1

Answer: The range for a correlation coefficient is from a perfectly negative correlation of -1.0 to a perfectly positive correlation of +1.0. For diversification purposes, the lower the correlation coefficient, the greater the risk reduction and therefore, the greater the preference by investors for adding securities that have low to negative correlation coefficients with their existing portfolios. Keep in mind that most publicly traded stocks have positive correlation coefficients with one another.

Answer to Question 2

Answer: Diversification is the practice of spreading your investment among different assets in an attempt to reduce the variability or uncertainty of returns. The benefit lies in the reduction of risk, not in the increase of expected returns. In fact, the expected return of a diversified portfolio consisting of assets with different expected rates of return will always have an expected return that is lower than the asset with the greatest expected return. So, no, diversification will NOT always lead to greater expected portfolio returns.