Question

1. Flordia Company (FC) and Minnesota Company (MC) are both Multinational Corporations. Their stock returns for the past three years were as follows: FC: -7 percent, 16 percent, 24 percent; MC: 10 percent, 12 percent, 26 percent. You are required to calculation the followings: (Please show correct formulas and detailed workouts)

c. The correlation coefficient between the returns of FC and MC.

d. If FC and MC are combined into a portfolio with 50 percent of the funds invested in each stock, calculate the expected return on the portfolio.

(multi-part question)

Answer 1

Calculation of Expected return of FC:

Expected return of FC= Return of all years/No.of years

= -7%+16%+24%/3

= 33%/3

= 11%

Expected return of MC = 10%+12%+26%/3

= 48%/3

= 16%

Calculation of Standard deviation of FC:

Return	Return-Expected return	Variance
-7%	-7%-11%=-18% or -0.18	(-0.18)^2=0.0324
16%	16%-11%=5% or 0.05	(0.05)^2=0.0025
24%	24%-11% = 13% or 0.13	(0.13)^2 =0.0169
	Variance	0.0518

Standard deviation= Square root of Variance

= Square root of 0.0518

= 0.2276 or 22.76%

Calculation of Standard deviation of MC:

Return	Return-Expected return	Variance
10%	10%-16%=-6% or -0.06	(-0.06)^2=0.0036
12%	12%-16%=-4% or -0.04	(-0.04)^2= 0.0016
26%	26%-16%= 10% or 0.1	(0.1)^2 = 0.01
	Variance	0.0152

Standard deviation= Square root of 0.0152

=0.1233 or 12.33%

Calculation of covariance of FC and MC:

Return-Expected return of FC (1)	Return-Expected return of MC (2)	Covariance (3) (1*2)
-0.18	-0.06	0.0108
0.05	-0.04	-0.002
0.13	0.1	0.013
	Covariance	0.0218

Correlation coefficient between FC and MC = Covariance/std devia of FC*std devia of MC

= 0.0218/0.2276*0.1233

= 0.0218/0.0281

= 0.7758 or 77.58%

d: Calculation of Expected return of portfolio:

Stock	Probability (1)	Return (2)	Expected return (3) (1*2)
FC	0.5	11%	5.5%
MC	0.5	16%	8%
		Expected return	13.5%