The covariance between the returns on two assets is negative. This occurs when ________.
A) the variance of one asset has a negative linear relationship with the variance of the other asset
B) the standard deviation of one asset has a positive linear relationship with the standard deviation of the other asset
C) on average, the return on one asset is below its expected value and the return on the other asset is above its expected value
D) on average, the return on one asset is below its expected value and the return on the other asset is below its expected value

Question

Quizplus · Accepted Answer

Negative covariance implies that the returns on one asset tend to be lower than expected when the returns on the other asset are higher than expected. Therefore, choice C is the correct answer. Choices A and B refer to the relationship between the variances or standard deviations of the assets, which are not necessarily related to their covariance. Choice D suggests that both assets have below-expected returns, but it does not specify the relationship between the returns of the two assets, which is necessary to determine the covariance.

The Covariance Between the Returns on Two Assets Is Negative