FRM Part I · FRM Exam Part I · Fundamentals of Probability
Two assets X and Y have a covariance of 0.0018. The standard deviation of X is 6% and the standard deviation of Y is 5%. What is the correlation between X and Y?
The correlation is 0.60. Correlation equals covariance divided by the product of the two standard deviations, so 0.0018 divided by (0.06 times 0.05, which is 0.003) gives 0.60. Using variances instead of standard deviations would give a wrong figure.
- A0.30
- B0.60Correct
- C0.36
- D0.06
Explanation
Correlation = Cov/(σX σY) = 0.0018/(0.06 × 0.05) = 0.0018/0.003 = 0.60. Option 0.36 results from using the product of variances rather than standard deviations in a wrong way, and 0.30 comes from halving the result.
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