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5. Diversification reduces the overall risk of a portfolio because of a factor called correlation. Explain how a stock with a return standard deviation of
5. Diversification reduces the overall risk of a portfolio because of a factor called correlation. Explain how a stock with a return standard deviation of 20% can be combined with a stock with a return standard deviation of 13.2% and result in a portfolio whose return standard deviation is much lower than the standard deviations of the two individual stocks? What is it about the correlation coefficient between stocks which reduces portfolio risk?
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