Variance formula

CFA Level III
#1

Asset class Global Equity sensitivity Global bonds sensitivity Residual risk Real estate equities 0.6 0.15 4.4% Other information Variance 0.025 0.0014

We are calculating the variance of real estate: 0.6^2 x 0.025^2 + 0.15^2 x 0.0014 + 2 x 0.6 x 0.15 x 0.002 + 0.044 Why in the answer does the formula add the residual risk at the end (4.4%)?

#2

Why are you squaring the variance? I guess that was a typo.

Residual risk can be derived by solving for the variance of the error term, if not given. But it is part of the equation.

#3

+1 w/ MrSmart

You’re squaring the already squared SD.

its a variance “normal” formula but remember to add the residual risk inside the root square part and thats it.

Also I dont remember if .002 is the correlation. This is from a mock or something right? remember that question.

#4
  1. Are the sensitivitis standard deviations? 2. If the residual risk is included, do we always add it at the end? All the other variance questions I have seen do not include residual risk, hence why i haven’t seen it before.
#5

As you post Variance .025 and in the formula you put .025^2 you are squaring the variance right? Yes you do my friend. When talking about ICAPM you do. As the textbook says (CFA way)