Respuesta :
Answer:
The less the correlation between two variables means the more different their output is.
A.) If Rachel wants to diversify her investment by investing on bonds that do not closely follow the returns on the bond. then she should invest in the stocks with low correlation with bonds. I.e: small cap stocks.
B.) Similarly, due to low correlation, small cap bonds will increase ( comparatively to large cap bonds) as the return on her bonds wil drop and vice versa.
Correlation coefficient is the relation between two variables. Richel needs to invest in small-cap stocks as they have less relation with the municipal bond.
What is the correlation coefficient?
The correlation coefficient helps us to know how strong is the relation between two variables. Its value is always between +1 to -1, where, the numerical value shows how strong is the relation between them and, the '+' or '-' sign shows whether the relationship is positive or negative.
1 indicates a strong positive relationship.
-1 indicates a strong negative relationship.
A result of zero indicates no relationship at all, therefore, independent variable.
A.) We know that the correlation coefficient helps us to know the relation between the two variables. Now, since Rachel needs a diversified portfolio had she had already invested in municipal bonds, therefore, she needs to invest in another asset that is very less related to municipal bonds so that if the value of the bonds decreases her portfolio is still managed by the other asset. Thus, Richel needs to invest in small-cap stocks as they have less relation with the municipal bond.
B.) If Rachel wants an investment that tends to increase when the return on her bonds drops, therefore, she needs to look for something that has a negative correlation with the bonds also, the correlation must be as close as possible to -1, so that the relation between the two is strong and negative.
Learn more about Correlation Coefficients:
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