Financial Risk Manager Part 1
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Hakim Ahmed has recently joined Lampard Investment Inc. He has been given data related to the assets of a client's portfolio provided in the following table:
Variance Asset X | 0.1225
Variance Asset Z | 0.3721
Covariance | 0.19
If the weight of Asset X is 35% and the weight of Asset Z is 65%, then what is the correlation coefficient between Assets X and Z?
Other
Community
NNikitesh
A
0.8899
B
0.0469
C
0.4412
D
0.4168
Explanation:
Step-by-step calculation:
-
Calculate standard deviations:
- Standard deviation of X = √(Variance of X) = √0.1225 = 0.35
- Standard deviation of Z = √(Variance of Z) = √0.3721 = 0.61
-
Apply correlation coefficient formula: Correlation coefficient = Covariance(X,Z) / (σ_X × σ_Z) = 0.19 / (0.35 × 0.61) = 0.19 / 0.2135 = 0.8899
Key points:
- The correlation coefficient calculation does NOT use portfolio weights - weights are irrelevant for this calculation
- Correlation coefficient formula: ρ = Cov(X,Z) / (σ_X × σ_Z)
- The result of 0.8899 indicates a strong positive correlation between Assets X and Z
- The weights (35% for X, 65% for Z) are a distractor in this question
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