Marjon A.

Limot TTH 7:00-8:30 PM

BSBA-3B October 15, 2020
FM 131: Portfolio & Investment ASSIGNMENT
Prof: Ms. Kaulani Dagani

What is correlation, and why it is important with respect to portfolio returns?

Answer:
Correlation is a statistical measure of the relationship between two series of
numbers. Correlations are used in advanced portfolio management, computed as
the correlation coefficient, which has a value that must fall from negative one to positive one.

The correlation between asset returns is important because, when evaluating the effect of a new
asset on the portfolio's overall risk. Once the correlation between asset returns is known, the
investor can choose those that, when combined, reduce risk.

Describe the characteristics of returns that are:

Positively correlated it is a relationship between two variables in which both variables move in
the same direction. Therefore, when one variable increase as the other variable increases, or one
variable decrease while the other decreases. An example of positive correlation would be height
and weight. Taller people tend to be heavier.
Negatively correlated it is a relationship between two variables in which an increase in one
variable is associated with a decrease in the other. An example of negative correlation would be
height above sea level and temperature. As you climb the mountain (increase in height) it gets
colder (decrease in temperature). However, Negative correlation is a key concept in portfolio
construction, as it enables the creation of diversified portfolios that can better withstand portfolio
volatility and smooth out returns.
Uncorrelated it exists when there is no relationship between two variables. For example, there is
no relationship between the amount of tea drunk and level of intelligence.

Differentiate between perfect positive correlation and perfect negative correlation

Answer:
The difference between a perfect positive correlation and perfect negative correlation is that a
perfectly positive correlation means that 100% of the time, the variables in question move
together by the exact same percentage and direction, whereas a positive correlation can be seen
between the demand for a product and the product's associated price while the perfect negative
correlation means the relationship that exists between two variables is negative 100% of the
time.
However, In statistics, a perfect negative correlation is represented by the value -1, a 0 indicates
no correlation, and a +1 indicates a perfect positive correlation. A perfect negative
correlation means the relationship that exists between two variables is negative 100% of the
time.