FRM Part II · FRM Exam Part II · Correlation Basics: Definitions, Applications, and Terminology
Two assets have volatilities of 20% and 30%. An analyst calculates the covariance as 0.027. What is the correlation coefficient?
The correlation is 0.45, found by dividing the covariance of 0.027 by the product of the two volatilities, 0.20 times 0.30 equals 0.06.
- A0.45Correct
- B0.90
- C0.162
- D0.54
Explanation
Correlation = covariance/(σ1σ2) = 0.027/(0.20 x 0.30) = 0.027/0.06 = 0.45. Dividing by only one volatility or multiplying by them gives wrong values such as 0.162 (0.027 x 0.06 is far smaller; 0.162 arises from other misuse).
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