CMA Final · Strategic Financial Management · Portfolio Theory and Practice
Two securities have standard deviations of 10% and 20%, and the covariance between them is 100 (in %-squared units). What is the correlation coefficient between them?
The correlation coefficient is 0.50. It equals covariance divided by the product of the two standard deviations, which is 100 divided by 200. The result lies within the valid range of -1 to +1.
- A0.25
- B0.50Correct
- C0.75
- D5.00
Explanation
Correlation = covariance/(σ1×σ2) = 100/(10×20) = 0.50. Using 100/(10+20) would give a wrong 3.33 and is not a valid formula. The value 0.50 lies within -1 to +1, as required.
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