I have a query in portfolio management. A question from Schweser says that combining any two risky assets will not reduce unsystematic risk compared to a portfolio holding only one of the two risky assets, but adding a risky stock to a less risky bond portfolio can decrease portfolio risk. Is this based on the explanation that in order to achieve diversification benefit, we must add assets (stocks, bonds etc) that have low correlation between them.
Secondly, within assets, correlations of returns must be high such that if I want to add more equity stocks to the portfolio, they must have a high correlation of returns with the existing stocks in the portfolio. How does one explain high correlation of returns within an asset class?
In the following question then, the security would mean a different asset class? (The answer is -1)
In order to maximize diversification benefits, an investor should add a security with a correlation to the existing portfolio closest to: