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CMA Final · Strategic Financial Management · Portfolio Theory and Practice

Security A has a standard deviation of 10% and Security B has a standard deviation of 20%. The correlation coefficient between their returns is +0.4. What is the covariance between A and B (in %²)?

The covariance is 80 (in %²). Covariance equals the correlation coefficient multiplied by both standard deviations, so 0.4 × 10 × 20 gives 80. Leaving out the correlation would give 200, which overstates co-movement.

  1. A80Correct
  2. B200
  3. C12
  4. D8

Explanation

Covariance = correlation × σA × σB = 0.4 × 10 × 20 = 80 (%²). Option 200 ignores the correlation. Option 12 wrongly multiplies 0.4 by the sum of the standard deviations (10 + 20 = 30).

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