Question

10. Security X has expected return of 12% and standard deviation of 20%. Security Y has expected return of 15% and standard deviation of 27%. If the two securities have a correlation coefficient of 0.7, what is their covariance

Answer 1

Answer: 0.0378

Explanation:

The Covariance of securities refer to the relationship between two securities in terms of their movement together. A postie covariance means that securities usually move in the same direction while a negative means that they move in opposite directions. It can therefore be useful in portfolio diversification.

The formula is;

= Standard deviation of X * Standard deviation of Y * Correlation Coefficeint

= 20% * 27 * 0.7

= 0.0378