Covariance and portfolio risk?

Question

If you have two stocks that produce a covariance of 43.25; how is portfolio risk affected by adding these?

Answer 1

Covariance is a way to tell how closely two random variables are related. So, for example, stock A is closely related to Stock B, knowing about stock A can help you predict what will happen to stock B.

I don't know anything about the data being used in your case but since 43.25 is greater than zero there is some relationship between the two stocks. The reason that knowing this will help with portfolio risk is because you can, in  a way, guess what is going to happen to one of the stocks based on the other, effectively lowering some of your risk. If you had a covariance of 0 you would not be able to do this and, in theory, your risk would be higher because there is a greater degree of unknown.

Hope this helps, good luck!