An investment analyst prepares thefollowing distribution of the prices of two equity stocks, A and B,she expects to see at the end of the coming financial year in eachof five states. The probability that each state might occur hasalso been estimated and is noted below. The current prices in themarket are £45 and £38 per share for A and B respectively.
State | 1 | 2 | 3 | 4 | 5 |
Probability | 0.10 | 0.15 | 0.25 | 0.25 | 0.25 |
Stock A | | | | | |
Prices (£) | 39.53 | 40.78 | 43.63 | 43.88 | 49.56 |
Stock B | | | | | |
Prices (£) | 23.50 | 33.11 | 38.58 | 44.02 | 44.59 |
- For both stocks A and B, calculate the expected return, thevariance of the returns and the inter-quartile range of thereturns.
- Calculate the covariance between the returns of A and B.
- Calculate the correlation between the returns of A and B, usingthe correlation function in Excel, as well as, directly usingformulae. Explain the difference in the two correlationvalues.
- For both stocks A and B, calculate the negative semi-varianceof the return at the end of the year. Why might investors takeaccount of the negative semi-variance of the returns as a measureof risk?
