Answer: -0.5

The correct answer is **A** (-0.5). The correlation coefficient measures the degree to which two assets move in relation to each other. A correlation of -0.5 indicates a negative relationship, which is the most effective among the given options for reducing portfolio risk. This is because diversification benefits are maximized when assets are not perfectly correlated. Specifically: - **Perfect positive correlation (ρ = +1)**: Portfolio risk is unaffected, as the standard deviation of the portfolio is a weighted average of the individual asset risks. - **Imperfect correlation (ρ < +1)**: Portfolio risk decreases as the correlation coefficient moves away from +1. Lower values of ρ (closer to -1) further reduce risk. - **Perfect negative correlation (ρ = -1)**: Under certain conditions, the portfolio can be made risk-free. The standard deviation of a two-asset portfolio is given by: $$\sigma_p = \sqrt{w_1^2 \sigma_1^2 + w_2^2 \sigma_2^2 + 2w_1w_2\rho_{12}\sigma_1\sigma_2}$$ Since the standard deviation is a strictly increasing function of ρ, the smallest correlation coefficient (-0.5) results in the lowest portfolio risk.

Author: LeetQuiz Editorial Team