CFA Level I · CFA Level I Exam · The Return and Risk of a Financial Portfolio
Two assets have standard deviations of 20% and 30% and a correlation of 0.40. The covariance between their returns is closest to:
The covariance is 0.0240. Covariance equals the correlation times both standard deviations: 0.40 × 0.20 × 0.30 = 0.024. Ignoring the correlation would give 0.06, which overstates the co-movement.
- A0.0120
- B0.0240Correct
- C0.0600
Explanation
Covariance = ρ × σ1 × σ2 = 0.40 × 0.20 × 0.30 = 0.0240. The 0.0600 option omits the correlation; 0.0120 uses 0.20 as the correlation factor.
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