Final answer:
Portfolio theory suggests that combining two risky assets can lead to a portfolio standard deviation that is lower than either of the individual assets due to diversification, especially when the asset returns are not perfectly correlated. The correct answer is A) lower than any of the individual standard deviations.
Step-by-step explanation:
According to portfolio theory, it is theoretically possible to combine two risky assets resulting in an overall portfolio standard deviation that is lower than any of the individual standard deviations. This is due to the concept of diversification, which involves spreading investments across various assets to reduce risk.
Diversification benefits arise when the asset returns are not perfectly correlated; some assets will perform well when others do not, which can reduce the overall volatility of the portfolio.
The tradeoff between expected return and the degree of risk is fundamental in investment choices. Higher risk is usually associated with the potential for higher returns — for example, stocks versus bonds or savings accounts.
By diversifying investments and carefully selecting assets with differing risk and return profiles, investors can aim to achieve a more favorable balance of risk and return in their portfolios.