Question

Why is an investment portfolio containing a mix of stocks and bonds less risky than one containing a single asset class?
A. Because stocks and bonds are negatively correlated.
B. Because bonds typically have a high variance and stocks typically have a low variance.
C. Because the markets for stocks and bonds tend to move in the same direction at the same time.
D. Because stocks and bonds are positively correlated.

Answer 1

Answer: A. Because stocks and bonds are negatively correlated

Explanation:

An investment portfolio containing a mix of stocks and bonds is less risky than one containing a single asset class because stocks and bonds are negatively correlated.

In business, diversification of ones portfolio is essential in order to mitigate risks. Stocks and bonds are negatively correlated as one goes up, the other falls. Therefore bonds and stocks compensate each other.