Table of Contents
- 1 How would you characterize the correlation of returns of the two assets?
- 2 What correlation is best for diversification?
- 3 How would the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk explain?
- 4 How can you tell if two stocks are uncorrelated?
How would you characterize the correlation of returns of the two assets?
The Correlation Scale
- If two assets have an expected return correlation of 1.0, that means they are perfectly correlated.
- A perfectly negative correlation (-1.0) implies that one asset’s gain is proportionally matched by the other asset’s loss.
- A zero correlation indicates the two assets have no predictive relationship.
Why is the correlation between asset returns important how do correlation helps to construct a good portfolio?
When it comes to diversified portfolios, correlation represents the degree of relationship between the price movements of different assets included in the portfolio. If two pairs of assets offer the same return at the same risk, choosing the pair that is less correlated decreases the overall risk of the portfolio.
What is the most desired correlation between two assets?
A perfect positive correlation between two assets has a reading of +1. A perfect negative correlation has a reading of -1.
What correlation is best for diversification?
Therefore, the closer the correlation coefficient is to 0, the more uncorrelated two assets are and the better the diversification. So a correlation coefficient of 0.85 indicates a much higher correlation between two investments than one that is 0.42.
How do you choose uncorrelated stocks?
If it’s -1, the stocks move in the opposite directions (i.e. if one stock rises, the other stock goes down), if it’s equal to 1, the stock move perfectly in the same direction. If it’s equal to 0, the stocks are uncorrelated and their movements are independent of each other.
Is Beta same as correlation?
Beta tries to measures the effect of one variable impacting the other variable. Correlations measure the possible frequency of similarly directional movements without considerations of cause and effect. Beta is the slope of the two variables. Correlation is the strength of that linear relationship.
How would the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk explain?
How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk? The individual projects risk may have little impact on stockholder’s risk, viewing it in context of entire company.
Why is the correlation between asset returns important?
The correlation between asset returns is important when evaluating the effect of a new asset on the portfolio’s overall risk. Even if assets are not negatively correlated, the lower the positive correlation between them, the lower the resulting risk.
How do you calculate correlation between returns?
To find the correlation between two stocks, you’ll start by finding the average price for each one. Choose a time period, then add up each stock’s daily price for that time period and divide by the number of days in the period. That’s the average price. Next, you’ll calculate a daily deviation for each stock.
If two stocks are highly correlated, they will likely move in the same direction (i.e. if a stock price rises, the other stock price rises too) or in the opposite direction. If it’s equal to 0, the stocks are uncorrelated and their movements are independent of each other.
Is beta always greater than correlation?
If beta > 0 then correlation coefficient is positive. If beta < 0 then correlation coefficient is negative. If beta =0 then there is no correlation between X and Y.
What is the difference between R and beta?
Beta and R-squared are two related, but different, measures. R-squared measures how closely each change in the price of an asset is correlated to a benchmark. Beta measures how large those price changes are in relation to a benchmark.