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Covariance and Correlation Based on the following information, calculate the expected return and standard deviation of...

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Finance

  1. Covariance and Correlation Based on the following information,calculate the expected return and standard deviation of each of thefollowing stocks. Assume each state of the economy is equallylikely to happen. What are the covariance and correlation betweenthe returns of the two stocks?

STATE OF ECONOMY

RETURN ON STOCK A

RETURN ON STOCK B

Bear

Normal

Bull

-.032

.124

.193

-.103

-.025

.469

Answer & Explanation Solved by verified expert
3.7 Ratings (540 Votes)

Stock A
Scenario Probability Return% =rate of return% * probability Actual return -expected return(A)% (A)^2* probability
Bear 0.15 -3.2 -0.48 -13.745 0.002833875
Good 0.5 12.4 6.2 1.855 0.000172051
Bull 0.25 19.3 4.825 8.755 0.001916251
Expected return %= sum of weighted return = 10.55 Sum=Variance Stock A= 0.00492
Standard deviation of Stock A% =(Variance)^(1/2) 7.02
Stock B
Scenario Probability Return% =rate of return% * probability Actual return -expected return(A)% (B)^2* probability
Bear 0.15 -10.3 -1.545 -19.23 0.005546894
Good 0.5 -2.5 -1.25 -11.43 0.006532245
Bull 0.25 46.9 11.725 37.97 0.036043023
Expected return %= sum of weighted return = 8.93 Sum=Variance Stock B= 0.04812
Standard deviation of Stock B% =(Variance)^(1/2) 21.94
Covariance Stock A Stock B:
Scenario Probability Actual return% -expected return% for A(A) Actual return% -expected return% For B(B) (A)*(B)*probability
Bear 0.15 -13.745 -19.23 0.003964745
Good 0.5 1.855 -11.43 -0.001060133
Bull 0.25 8.755 37.97 0.008310684
Covariance=sum= 0.011215297
Correlation A&B= Covariance/(std devA*std devB)= 0.728718129

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Transcribed Image Text

Covariance and Correlation Based on the following information,calculate the expected return and standard deviation of each of thefollowing stocks. Assume each state of the economy is equallylikely to happen. What are the covariance and correlation betweenthe returns of the two stocks?STATE OF ECONOMYRETURN ON STOCK ARETURN ON STOCK BBearNormalBull-.032.124.193-.103-.025.469

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