Question

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 0.09 and 0.15, respectively. (Round your answer to 4 decimal places. For example .1244)

Answer 1

Answer Pageno Probability retwm(A) retuomce) Good 0.35 0.3 0.5 ok 0.5 0.1 0.1 Poor Oo15 -0.25 -0.3 we Caluclate the covariance between return of stock (A) and stock (B). Let al. The expected retom for A=0.09 and 13=0.15 formula :- coveriance = Porobability of < (retwm (a) - Expected Rotwom(a) * (retum (8) - Expected Return(B)) return Four ok = for Good = 0.35% (0.3 -0.09) Co.5 -0.15)=0-0257 0-5(0.1-0.09) (0.1-0.15) =-0.0062 Foor poor = 0.15(-0.25-0.09) (-0.3 -0.15)=0.0229 = 0.0257 -0.0002 +0.0229 = 0.0484 The covariance betweent the oretwins of stock ARB = = 0.0484 Total Covariance