Question

Create a portfolio using the two stocks and information below:

	Expected Return	Standard Deviation	Weight in Portfolio
Stock A	34.00%	19.00%	90.00%
Stock B	9.00%	38.00%	10.00%
----------------------	----------------------	----------------------	----------------------
Correlation (A,B)	0.1500	----------------------	----------------------

(Do not round intermediate calculations. Record your answers in decimal form and round your answers to 4 decimal places. Ex. x.xxxx)

What is the variance of A?

What is the variance of B?

What is the Correlation (A,A)?

What is the Correlation (B,B)?

What is the Covariance (A,A)?

What is the Covariance (A,B)?

What is the Covariance (B,A)?

What is the Covariance (B,B)?

What is the expected return on the portfolio above?

What is the variance on the portfolio above?

What is the standard deviation on the portfolio above?

Answer 1

Variance of A

= Square of Standard deviation

= 0.19*0.19

= 3.61 %

Variance of B

= Square of Standard deviation

= 0.38*0.38

= 14.44 %

Correlation (A,A)

The correlation coefficient is a measure that determines the degree to which two variables' movements are associated.

So for the same variable it will be 1 only

Correlation (B,B)

The correlation coefficient is a measure that determines the degree to which two variables' movements are associated.

So for the same variable it will be 1 only

Covariance (A,A)

Covariance measures how the mean values of two variables move together

So between same variabes it will be 1 only

Covariance (B,B)

Covariance measures how the mean values of two variables move together

So between same variabes it will be 1 only

Covariance (A,B)

Covariance measures how the mean values of two variables move together

= Deviation of A X Deviation of B

= 0.19 X 0.38

= 0.0722

Covariance (B,A)

Covariance measures how the mean values of two variables move together

= Deviation of B X Deviation of A

= 0.38 X 0.19

= 0.0722

Expected Return on Portfolio

=( Expected return of A X Weight of A ) + ( Expected return of B X Weight of B )

= 34 X 0.9 + 9 X 0.1

= 30.6 + 0.9

= 31.5 %

Variance on the portfolio

LET STANDARD DEVIATION OF A = SDA

STANDARD DEVIATION OF B = SDB

WEIGHT OF A = WA

WEIGHT OF B = WB

= WAXWA X SDAXSDA + WBXWB X SDBXSDB + 2 X WAXWBXSDAXSDBXCORRELATION COEFFICIENT A,B

= 0.9X0.9X0.19X0.19 + 0.1X0.1X0.38X0.38 + 2X0.9X0.1X0.19X0.38X0.15

= 0.0326

Standard deviation on the portfolio

Square root of Variance

= Square root of 0.0326

= 18.06 %