Question

The covariance between the returns on two assets is negative. This occurs when _______.

a. the variance of one asset has a negative linear relationship with the variance of the other asset
b. the standard deviation of one asset has a positive linear relationship with the standard deviation of the other asset
c. on average, the return on one asset is below its expected value and the return on the other asset is above its expected value
d. on average, the return on one asset is below its expected value and the return on the other asset is below its expected value

Answer 1

The negative covariance between two assets' returns signifies that, typically, if one asset's return is less than expected, the other's is more than expected, reflecting a negative correlation. Option C is corrcet.

Step-by-step explanation:

The covariance between the returns on two assets is negative. This occurs when, on average, the return on one asset is below its expected value and the return on the other asset is above its expected value. This situation is indicative of a negative correlation where the two assets move in opposite directions. For example, if Asset A's returns decrease, Asset B's returns increase and vice versa. This negative relationship illustrates that the variables are inversely related to each other, displaying a negative slope on a graph.