Question

The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________.

Answer 1

Answer: The Covariance in the portfolio is -0.002

Explanation: Covariance is a significant tool in modern portfolio theory that is use to check risk and volatility, and to determine the relationship between the movement of assets returns in the portfolio.

CALCULATE COVARIANCE:

Correlation of sample = Covariance of sample ÷ (standard deviation of sampleA × standard deviation of sampleB)

Standard deviation A = 0.10

Standard deviation B = 0.04

Correlation = -0.5

Therefore;

Covariance = (0.04 × 0.10) × (-0.5) = -0.002

The Covariance is -0.002, which shows a negative since, thant means the two assets does not move in the same direction in the portfolio. Which means that, when asset A generate profit, asset B will generate loss to cancel the profit.