FRM Part II · FRM Exam Part II · Correlation Basics: Definitions, Applications, and Terminology
Asset A has a return standard deviation of 10% and Asset B has 20%. The covariance between their returns is 0.0090. What is the correlation coefficient?
Correlation equals covariance divided by the product of the standard deviations. Here 0.0090 divided by 0.10 times 0.20, which is 0.0200, gives 0.45.
- A0.45Correct
- B0.90
- C0.045
- D2.25
Explanation
Correlation = covariance / (σA × σB) = 0.0090 / (0.10 × 0.20) = 0.0090 / 0.0200 = 0.45. Using 0.90 would result from dividing by only 0.01, a wrong denominator. Check: 0.45 × 0.02 = 0.009.
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