Page 45 - FINAL CFA SLIDES DECEMBER 2018 DAY 3

Session Unit 2:

9. Probability Concepts

LOS 9.k: Calculate and interpret covariance and correlation, p.182.

Variance measures how a random variable moves with itself, and the covariance measures

how one random variable moves with another random variable

Covariance is a probability-weighted measure of how two assets move together.
Cov(Ri, Rj) = E{[Ri – E(Ri)] * [Rj – E(Rj)]}

Key features:

• The covariance of RA with itself is equal to the variance of RA; that is, Cov(RA,RA) =

Var(RA).

• The covariance may range from negative infinity (move in opposite directions)

to positive infinity (move in tandem, same direction)