Question

Consider the following table:

			Stock Fund			Bond Fund
Scenario	Probability		Rate of Return			Rate of Return
Severe recession	0.10		–43	%		–10	%
Mild recession	0.20		–23	%		16	%
Normal growth	0.40		28	%		9	%
Boom	0.30		33	%		–6	%

a.Calculate the values of mean return and variance for the stock fund. (Do not round intermediate calculations. Round "Mean return" value to 1 decimal place and "Variance" to 2 decimal places.)

b.Calculate the value of the covariance between the stock and bond funds. (Negative value should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Answer:

STEPS:

1.Determine Mean= Probability x rate of return( say a)

2. Determine Da = A-a.

3. Determine Da².

4. Determine Variance of return= Probability x Da².

5. For finding Co variance multiply Da and Db.

Note: Covariance is a measure of how changes in one variable are associated with changes in second variable.

DETAILED CALCULATION IS SHOWN BELOW:-

1. Calculation of MEAN RETURN:

Scenario	Probability	Stock Fund    (A)	Bond Fund (B)	a	b
		Rate of Return	Rate of Return	2x3	2x4
Severe recession	0.1	-43	-10	-4.3	-1
Mild recession	0.2	-23	16	-4.6	3.2
Normal growth	0.4	28	9	11.2	3.6
Boom	0.3	33	-6	9.9	-1.8
Mean Return				12.2	4

2. Calculation Of Variance and Co Variance

Scenario	Probability(Pro)	Da=A-a	Db=B-b	Da SQRT	Db SQRT	Da SQRTxPro	Db SQRTxPro	Z=DaxDb	Zx Pro
Severe recession	0.1	-55.2	-14	3047.04	196	304.704	19.6	772.8	77.28
Mild recession	0.2	-35.2	12	1239.04	144	247.808	28.8	-422.4	-84.48
Normal growth	0.4	15.8	5	249.64	25	99.856	10	79	31.6
Boom	0.3	20.8	-10	432.64	100	129.792	30	-208	-62.4
Variance						782.16	88.4
Co Variance									-38