CFA Level I · CFA Level I Exam · The Return and Risk of a Financial Portfolio
The correlation between the returns of Fund A and Fund B is 0.60. Fund A has a standard deviation of 20% and Fund B has a standard deviation of 15%. The covariance of their returns is closest to:
The covariance is 0.0180. Covariance equals the correlation multiplied by both standard deviations, so 0.60 times 0.20 times 0.15 gives 0.018. Leaving out the correlation would overstate the figure at 0.03.
- A0.0180Correct
- B0.0300
- C0.1800
Explanation
Covariance = correlation × σA × σB = 0.60 × 0.20 × 0.15 = 0.0180. The 0.0300 option omits the correlation, using only the product of standard deviations. The 0.1800 option is a decimal-placement error from using percentages as whole numbers incorrectly.
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