The correct answer is: B. Combining two securities having perfect negative correlation in their expected returns
The risk of a portfolio can be minimized by combining securities that have low or negative correlation with each other. This is because when the returns of two securities are negatively correlated, one security’s losses will tend to offset the other security’s gains. This can help to reduce the overall volatility of the portfolio.
A perfect negative correlation means that the returns of the two securities move in opposite directions. This is the ideal situation for risk reduction, as it means that the losses of one security will be perfectly offset by the gains of the other security.
A perfect positive correlation means that the returns of the two securities move in the same direction. This is the worst possible situation for risk reduction, as it means that the losses of one security will be magnified by the losses of the other security.
A partial positive correlation means that the returns of the two securities move in the same direction, but not perfectly. This is not as good as a perfect negative correlation, but it is still better than a perfect positive correlation.
A partial negative correlation means that the returns of the two securities move in opposite directions, but not perfectly. This is not as good as a perfect negative correlation, but it is still better than a perfect positive correlation.