7.Rafael Garza, CFA, is considering the purchase of ABC stock for a client’s portfolio. His analysis includes calculating the covariance between the returns of ABC stock and the equity market index. Which of the following statements regarding Garza’s analysis is most accurate?

A)   The covariance of two variables is an easier measure to interpret than the correlation coefficient.

B)   The actual value of the covariance is not very meaningful because the measurement is very sensitive to the scale of the two variables.

C)   A covariance of +1 indicates a perfect positive covariance between the two variables.

D)   The covariance measures the strength of the linear relationship between two variables.

The correct answer was B)

Covariance is a statistical measure of the linear relationship of two random variables, but the actual value is not meaningful because the measure is extremely sensitive to the scale of the two variables. Covariance can range from negative to positive infinity.