If the correlation coefficient between the returns on stock C and stock D is +1.0, the standard deviation of return for stock C is 15 percent, and that for stock D is 30 percent, calculate the covariance between stock C and stock D.
A)+45
B)-450
C)+450
D)-45

Question

Quizplus · Accepted Answer

Covariance of two securities A and B is given by the formula:
Covariance of A and B = ρ(A,B) * Std Dev of A * Std Dev of B
where ρ(A,B) is the correlation coefficient between A and B.
In this question, ρ(C,D) = +1.0, Std Dev of C = 15%, and Std Dev of D = 30%
Therefore, Covariance of C and D = ρ(C,D) * Std Dev of C * Std Dev of D
= +1.0 * 15% * 30%
= +4.5%
= +0.045 [in decimal]
Multiplying this with the average of the mean returns of stock C and stock D gives the expected return.
Therefore, the covariance between stock C and stock D is +450.

If the Correlation Coefficient Between the Returns on Stock C