Portfolio management question!!!

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gingerduck

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The correlation coefficient of portfolio X’s returns and the market’s return is 0.95, and the correlation coefficient of portfolio Y’s return and the market’s return is 0.60. which of the following statement best describes the levels of portfolio diversification?
a) both portfolio x and portfolio y are well diversified
b)both portfolio x and portfolio y are poorly diversified
c)portfolio x is well diversified but portfolio y is poorly diversified
d)portfolio x is poorly diversified and portfolio y is well diversified.
i am confused with the answer which is C.
the correlation coefficient of portfolio x and market return is 0.95 which is quite close to 1 to be a perfect correlated and same applies to correlation coefficient of portfolio y and market retun is 0.60. so i think both are poorly diversified. But loosely speaking, correlation coefficient of portfolio y and market retun can be said as well diversified compared to correlation coefficient of portfolio x and market retun.
am i missing sth here?
can someone please explain for me?
thanks,
 
I think there is something wrong with this question as
Corr= +1, means that the two portfolio returns move exactly in the same direction…hence there is no diversification effect
corr=0 means that there is no relationship between the two portfolio
Corr=-1 means that the two portfolio move exactly in the opposite direction, hence they are well diversified.
 
Whoa - The market portfolio is perfectly diversfied. That means that something close to the market portfolio is close to perfectly diversified. That means X is well diversified. I guess 0.6 means “poorly diversified”…
 
JoeyDVivre Wrote:
——————————————————-
> Whoa - The market portfolio is perfectly
> diversfied. That means that something close to
> the market portfolio is close to perfectly
> diversified. That means X is well diversified. I
> guess 0.6 means “poorly diversified”…
Thanks Joey…I didnt pay attention to the fact that the correlation of X was with the Market portfolio!…
You..know… small details :-)
 
To joey,
you reckon that market is well diversified? its quite tricky in the test…..i have no idea which one to choose if no further notes.
thanks,
JoeyDVivre Wrote:
——————————————————-
> Whoa - The market portfolio is perfectly
> diversfied. That means that something close to
> the market portfolio is close to perfectly
> diversified. That means X is well diversified. I
> guess 0.6 means “poorly diversified”…
 
The market portfolio is almost by definition that which is perfectly diversified. It’s the portfolio in which there is no longer any risk which can be reduced by diversification. Remember that in this portfolio management stuff “the market” isn’t referring to the S&P 500 or something. It’s referring to a hypothetical portfolio that has no unsystematic risk. You can make an argument that the market portfolio is a market-cap weighted index of all available investable securities so if you are limited to the US equity universe, that sounds a lot like the S&P 500 except for the, I dunno, 15,000 stocks not in the S&P 500.
 
Haha….
thanks so much!!!
JoeyDVivre Wrote:
——————————————————-
> The market portfolio is almost by definition that
> which is perfectly diversified. It’s the
> portfolio in which there is no longer any risk
> which can be reduced by diversification. Remember
> that in this portfolio management stuff “the
> market” isn’t referring to the S&P 500 or
> something. It’s referring to a hypothetical
> portfolio that has no unsystematic risk. You can
> make an argument that the market portfolio is a
> market-cap weighted index of all available
> investable securities so if you are limited to the
> US equity universe, that sounds a lot like the S&P
> 500 except for the, I dunno, 15,000 stocks not in
> the S&P 500.
 
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