CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part I
Which statement about covariance and correlation is most accurate?
Correlation is covariance divided by the product of the two assets' standard deviations. This standardization restricts it to between -1 and +1, whereas covariance is unbounded and changes with the scale or units of the returns.
- ACovariance is bounded between -1 and +1.
- BCorrelation is the covariance standardized by the two standard deviations.Correct
- CCovariance has the same value regardless of the units of return.
Explanation
Correlation is covariance divided by the product of the standard deviations, which standardizes it to the range -1 to +1. Covariance is unbounded and depends on the scale of the returns, so the other statements are wrong.
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