Calculate the expected return and standard deviation of each of the above stocks

Question

Calculate the expected return and standard deviation of each of the above stocks. Assume each state of the economy is equally likely to happen. (Do not include the percent signs (%). Round your answers to 2 decimal places, (e.g., 32.16)) What is the covariance between the returns of the two stocks? (Negative amount should be indicated by a minus sign. Round your answer to 6 decimal places, (e.g., 32.161616)) What is the correlation between the returns of the two stocks? (Negative amount should be indicated by a minus sign. Round your answer to 4 decimal places, (e.g., 32.1616))

Explanation / Answer

Consider the following ECONOMY 0.077 0.070

Bear 0.088 .128

Null 0.060 .190

Calculate the expected return and standard deviation of each of the

let me start defining the variables:

E(RA) = expected return on Stock A

E(RB) = expected return on Stock B

STDA = standard deviation of stock A

STDB = standard deviation of stock B

VarA = variance of stock A

VarB = variance of stock B

Cor(RA,RB) = correlation between RA and RB

Cov(RA,RB) = covariance between RA and RB

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Since it is not stated we can consider the same probability for each

possible state of the economy, that is 1/3, then:

E(RA) = (1/3)*(0.077) + (1/3)*(0.088) + (1/3)*(0.060) =

= 0.075= 7.5%

So the expected return on Stock A is 7.5%%.

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E(RB) = (1/3)*(-0.070) + (1/3)*(0.128) + (1/3)*(0.190) =

= 0.0826=

= 8.26%

The expected return on Stock B is 8.26%%.

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