Question

The returns on assets C and D are strongly correlated with a correlation coefficient of 0.80. The variance of returns on C is 0.0009, and the variance of returns on D is 0.0036. What is the covariance of returns on C and D?A) 0.03020.B) 0.00144.C) 0.40110.D) 1.44024.

Answer 1

Option (B) 0.00144

Step-by-step explanation:

Data provided in the question:

Correlation coefficient, r = 0.80

Variance of returns on C = 0.0009

Variance of returns on D, = 0.0036

Now,

r = Cov(C,D) / (σA x σB)

Thus,

covariance of returns on C and D, Cov(C,D) = r × (σA x σB)

also,

σA = (0.0009) × 0.5 = 0.03 [ Since there are two assets, weight = 0.5 ]

σB = (0.0036) × 0.5 = 0.06

Therefore,

covariance of returns on C and D, Cov(C,D) = 0.8 × 0.03 × 0.06)

or

covariance of returns on C and D = 0.00144

Hence,

Option (B) 0.00144