In: Finance
What is the variance of the returns on a portfolio that is invested 40 percent in Stock S and 60 percent in Stock T?
State of Economy |
Probability of State of Economy |
Rate of Return if State Occurs |
|||||||
Stock S |
Stock T |
||||||||
Boom |
.06 |
.22 |
.18 |
||||||
Normal |
.92 |
.15 |
.14 |
||||||
Bust |
.02 |
−.26 |
.09 |
.00091
.00136
.00107
.00118
Please show work
Stock S | |||||
Scenario | Probability | Return% | =rate of return% * probability | Actual return -expected return(A)% | (A)^2* probability |
Boom | 0.06 | 22 | 1.32 | 7.4 | 0.00032856 |
Normal | 0.92 | 15 | 13.8 | 0.4 | 1.472E-05 |
Bust | 0.02 | -26 | -0.52 | -40.6 | 0.00329672 |
Expected return %= | sum of weighted return = | 14.6 | Sum=Variance Stock S= | 0.00364 | |
Standard deviation of Stock S% | =(Variance)^(1/2) | 6.03 | |||
Stock T | |||||
Scenario | Probability | Return% | =rate of return% * probability | Actual return -expected return(A)% | (B)^2* probability |
Boom | 0.06 | 18 | 1.08 | 3.86 | 8.93976E-05 |
Normal | 0.92 | 14 | 12.88 | -0.14 | 1.8032E-06 |
Bust | 0.02 | 9 | 0.18 | -5.14 | 5.28392E-05 |
Expected return %= | sum of weighted return = | 14.14 | Sum=Variance Stock T= | 0.00014 | |
Standard deviation of Stock T% | =(Variance)^(1/2) | 1.2 | |||
Covariance Stock S Stock T: | |||||
Scenario | Probability | Actual return% -expected return% for A(A) | Actual return% -expected return% For B(B) | (A)*(B)*probability | |
Boom | 0.06 | 7.4 | 3.86 | 0.000171384 | |
Normal | 0.92 | 0.4 | -0.14 | -0.000005152 | |
Bust | 0.02 | -40.6 | -5.14 | 0.000417368 | |
Covariance=sum= | 0.0005836 | ||||
Correlation A&B= | Covariance/(std devA*std devB)= | 0.805977717 | |||
Variance | =( w2A*σ2(RA) + w2B*σ2(RB) + 2*(wA)*(wB)*Cor(RA, RB)*σ(RA)*σ(RB)) | ||||
Variance | =0.4^2*0.06033^2+0.6^2*0.012^2+2*0.4*0.6*0.06033*0.012*0.80598 | ||||
Variance | 0.00091 |