Question

1. How is correlation measured?

2. What is the importance of correlation in investment theory?

3. In Excel use a function = CORREL(highlight the first array of data: Market Return, second array of data: Stock A return).

Year Market Return,% Stock A return, %

2010 -6 -1

2011 1 0

2012 5 3

2013 -3 2

2014 0 5

2015 10 9

Find the correlation coefficient. Explain what that number means regarding stock A and market rate of return.

Answer 1

correlation is used to measure the relation between two variables. the degree of relationship is measured by the use of a Correlation Coefficient, (r), which is a number that describes the degree of relationship between two variables.

The correlation coefficient's value ranges from +1.0 to –1.0, which shows an indication of the strength and direction of the relationship.

correlation is used as a measurement of linear relationship between stock return and market returns. It specifies that on the change in market return hows the stock return will move and in which direction and the degree of change in stock return
Year	Market return in %	stock return in %
2010	-6	-1
2011	1	0
2012	5	3
2013	-3	2
2014	0	5
2015	10	9
Correlation coefficient- Using correl function in MS excel =correl(cell reference year 2010 market return: cell reference 2015 market return,cell reference year 2010 stock return: cell reference year 2015 stock return)		0.810281
Stock a return is highly correlated with the market return as a coefficient correlation value more than .5 show a positive relation and as it will increased towards 1 will shows a strong positive relation.