Question

1- A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 28%, while stock B has a standard deviation of return of 22%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .050, the correlation coefficient between the returns on A and B is _________ . a) .190 b) .285 c) .104 d ) .475

2- Historical returns have generally been __________ for stocks of small firms as (than) for stocks of large firms. a) higher b) none of these options (There is c) no evidence of a systematic relationship between returns on small-firm stocks and returns on large-firm stocks.) c) the same d) lower

Answer 1

(1)

A portfolio is composed of two stocks, A and B.

Stock A has a standard deviation of return of 28%, while stock B has a standard deviation of return of 22%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio.

If the variance of return on the portfolio is .050, the correlation coefficient between the returns on A and B is _________ . a) .190 b) .285 c) .104 d) .475

Variance of return on the portfolio is 0.05

Stock A has a standard deviation of return of 28%, ?_{A =} 28%

Stock B has a standard deviation of return of 22%, ?_{B =} 22%

Stock A comprises of 60% of the portfolio.

Stock B comprises of 40% of the portfolio.

Variance = (0.6)²*?²_A + (0.4)²*?²_B + 2(0.6)*(0.4)*?_A*?_B*(?_AB)

0.05 = 0.36*(0.28)²+0.16*(0.22)²+0.48*(0.28)*(0.22)*(?_AB)

0.05 = 0.028224 + 0.007744 + 0.029568*(?_AB)

0.029568*(?_AB) = 0.014032

(?_AB) = 0.475

The correlation coefficient between the returns on A and B is 0.475.

(2)

Historical returns have generally been higher for stocks of small firms as (than) for stocks of large firms.

a) higher

b) none of these options (There is no evidence of a systematic relationship between returns on small-firm stocks and returns on large-firm stocks.)

c) the same

d) lower

The stocks of the small firms perform better than the stocks of the large firms.

There is more year to year increase for the small firms.

Investors have earned super normal profits by investing in the shares of small firms.