FRM Part II · FRM Exam Part II · Correlation Basics: Definitions, Applications, and Terminology
Asset A has a standard deviation of 10% and asset B has a standard deviation of 20%. Their covariance is 0.0010. What is the correlation between A and B?
Correlation equals covariance divided by the product of standard deviations: 0.0010 divided by (0.10 times 0.20) equals 0.05. The correlation is therefore 0.05, indicating a very weak positive linear relationship.
- A0.05
- B0.50Correct
- C0.20
- D0.01
Explanation
Correlation = covariance / (sigma_A x sigma_B) = 0.0010 / (0.10 x 0.20) = 0.0010 / 0.02 = 0.05. Wait, 0.0010/0.02 = 0.05, so the result is 0.05. A distractor of 0.50 arises from mis-scaling.
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