Practice Quiz

FRM Financial Risk Manager Practice Test

Category - The Mean-Variance Portfolio Theory

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The covariance of two risky assets measures how two returns of two assets move in relation to each other. What happens to the relation between the two returns if the covariance is negative?
  1. Two returns move in the same direction.
  2. Two returns move in opposite directions.
  3. Two returns are equal.
  4. Two returns do not have any relation.
Explanation
When the covariance of two risky assets is negative, two returns of these two assets move in opposite directions. When the covariance of two risky assets is negative, two returns of these two assets move in the same direction.

Key Takeaway: Covariance can be positive, negative or zero.
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