Question

The standard deviation of return on investment B is 20%, and the standard deviation of return on investment C is 40%. The correlation coefficient between the returns on A and B is -0.4, the correlation coefficient between the returns on A and C is 0.6, and the covariance of returns on A and B is -0.02. The covariance between the returns on A and C is ________.

a.- 0.04

b.0.06

c.0.05

d.0.04

Answer 1

Correlation=cov(A,C)​/(SDa * SDc)

where:

cov(A,C)=Covariance between A and C

SDa​=Standard deviation of A

SDc=Standard deviation of C​

Applying the formula for Stocks A and B
Correlation = Covariance / Sda* SDb
-0.4 = -0.02/(SDa * 20%)
-0.08SDa = -0.02
SDa = 0.02/0.08
SDa = 0.25 or 25%
Therefore,
Correlation=cov(A,C)​/(SDa * SDc)
0.6 = cov(A,C) / (25% * 40%)
Cov (A,C) = 0.06
Therefore, option B is the correct answer.

answered by: anonymous