N2

Suppose we perform a principle component analysis of the correlation matrix of the returns of 13 yields along the yield curve. The largest eigenvalue of the correlation matrix is 9.8. What percentage of return volatility is explained by the first component? (You may use the fact that the sum of the diagonal elements of a square matrix is always equal to the sum of its eigenvalues.)

A. 64%

B. 75%

C. 98%

D. Cannot be determined without estimates of the volatilities of the individual return

Answer: B