The question doesn't really make sense, because as soon as they write √x in Statement 1, they are presupposing that x is not negative, since that expression is nonsense if x is negative, or at least it is on the GMAT, since the GMAT never tests "imaginary numbers". So just by virtue of the fact that they write √x and √y in Statement 1, neither x nor y can be negative, but if that's the case, Statement 1 cannot be true, since (√x)(√y) = √(xy) is always true if x and y are zero or greater.
So since this question only makes sense if you consider imaginary numbers, which are out of the scope of the GMAT, it's potentially a confusing question to study.
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