Question

In: Finance

Given the returns and probabilities for the three possible states listed here, calculate the covariance between...

Given the returns and probabilities for the three possible states listed here, calculate the covariance between the returns of Stock A and Stock B. For convenience, assume that the expected returns of Stock A and Stock B are 0.11 and 0.15, respectively. (Round your answer to 4 decimal places. For example .1244)

Probability

Return(A)

Return(B)

Good

0.35

0.30

0.50

OK

0.50

0.10

0.10

Poor

0.15

-0.25

-0.30

Solutions

Expert Solution

Covariance = √ probability × (return of A - expected return of A) (return of B - expected return of B)

= √ 0.35 (0.30 - 0.11)(0.50 - 0.15) + 0.50 (0.10 - 0.11) (0.10 - 0.15) + 0.15 (-0.25 - 0.11) (-0.30 - 0.15)

= √ 0.35 (0.19) (0.35) + 0.50 (-0.01) (-0.05) + 0.15 (-0.36) (-0.45)

= √ 0.35 (0.0665) + 0.50 (0.0005) + 0.15 (0.162)

= √ 0.023275 + 0.00025 + 0.0243

= √ 0.047825

= 0.2187

jeff jeffy answered 2 years ago
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