Page 19 - FINAL CFA I SLIDES JUNE 2019 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)