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anbu.edu
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FRM-Foundation

Postby anbu.edu » Tue Apr 09, 2013 4:27 pm

Which of the following statements regarding the covariance of rates of return is least accurate?

A) It is a measure of the degree to which two variables move together over time.
B) If the covariance is not positive, the rates of return on two investments will always move in different directions relative to their means.
C) If two variables have a negative covariance, this implies that, on average, when one goes up in value, the other goes down in value.
D) It is not a very useful measure of the strength of the relationship, there is absent information about the volatility of the two variables.
View Answer and Explanation
If the covariance is not positive, this does not mean that the returns will always move in opposite directions. They do on average, but not always.

Source Schweser
I dont understand the Cov can be only positive or negative . from what i understood if it is negative then they move in opposite direction. Please correct me if i am wrong

lokesh1
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Joined: Tue Apr 09, 2013 10:22 am

FRM-Foundation

Postby lokesh1 » Wed Apr 10, 2013 11:31 am

Dear Anbu : Positive covariance suggests that in general if one variable moves up the other will also move up but this is not true for all the readings. This is the minute difference between option b and c. For example stock market and a general stock return often have positive covariance but many days when stock market moves up many stocks move down or vice versa. Hence it is not for every reading but the average effect.


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