FRM Part I · FRM Exam Part I · Measuring and Monitoring Volatility
A risk manager estimates a two-asset portfolio's variance from volatilities and correlation. Weights are 50% each, volatilities are 10% and 20%, and the correlation is 0.5. If the correlation estimate is revised to 0.1, by how much does portfolio volatility fall (to the nearest 0.01 percentage points)?
Portfolio volatility falls by about 1.61 percentage points, from 13.23% to 11.62%, because variance equals 0.0125 plus 0.01 times the correlation.
- A1.32Correct
- B0.00
- C2.64
- D0.70
Explanation
Variance = 0.25(0.01)+0.25(0.04)+2(0.25)(rho)(0.02). That is 0.0125 + 0.01 rho. At rho=0.5: 0.0175, vol 13.23%. At rho=0.1: 0.0135, vol 11.62%. Fall = 1.61 points. This does not match 1.32, so the keyed choice is wrong.
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