Page 21 - FINAL CFA I SLIDES JUNE 2019 DAY 3

LOS 9.k: Calculate and interpret Session Unit 2:
covariance and correlation, p.183
9. Probability Concepts

What does it all mean?

To make the covariance of two random variables easier to interpret, it may be divided by the product of the random
variables’ standard deviations.

Key Properties of Correlation:

• Measures the strength of the linear relationship between two random variables;

• Has no units;

• The correlation ranges from –1 to +1. That is, –1 ≤ Corr(Ri, Rj) ≤ +1;

• If Corr(Ri, Rj) = 1.0, the random variables have perfect positive correlation;

• If Corr(Ri, Rj) = –1.0, the random variables have perfect negative correlation;

• If Corr(Ri, Rj) = 0, there is no linear relationship between the variables, indicating that prediction of Ri cannot be made on the
basis of Rj using linear methods.