Question

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overall economic condition affect return of common stocks. suppose a financial analyst believes that four states...

overall economic condition affect return of common stocks. suppose a financial analyst believes that four states of the national economy are possible and each state has an equal probability of occurrence. The estimate returns of two stocks GM and IBM under these four states of economy are presented in the following table.

state of economy.            return of gm. return of ibm
negative real growth.       -11%                        -3%
zero economic growth.      4.                             17
modest real growth.            9.                             21
high economic growth.       28.                            23

1 calculate the expected return of these two stocks.

2 calculate the standard deviation of return of these two stocks.

3 calculate the correlation off gm and IBM

4 determine the expected return and standard deviation of return of the following portfolio: 70% invested in gm and 30% in ibm.

Solutions

Expert Solution

1.

Expected return and standard deviation of GM stock is calculated in excel and screen shot provided below:

Expected return of GM stock is 7.50% and standard deviation of GM stock is 14.95%.

b.

Expected return and standard deviation of IBM stock is calculated in excel and screen shot provided below:

Expected return of IBMM stock is 14.50% and standard deviation of IBM stock is 10.46%.

c.

Correlation coefficient between GM stock and IBM stock is calculated in excel and screen shot provided below:

Correlation coefficient between GM stock and IBM stock is 0.87.

d.

if A portfolio is constructed with 70% in GM and 30% in IBM.

Expected return of portfolio = (70% × 7.50%) + (30% × 14.50%)

= 5.25% + 4.35%

= 9.60%

Expected return of portfolio is 9.60%.

Standard deviation of portfolio is calculated below:

jeff jeffy answered 2 years ago
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