Mr. Henry can invest in Highbull stock and Slowbear stock. His projection of the returns on these two stocks is as follows:
State of Economy Probability of State Return for Highbull Return for Slowbear
recession 0.25 -2.0% 5.0%
normal 0.60 9.02% 6.2%
boom 0.15 15.40% 7.4%
a. Calculate the expected return on each stock
b. Calculate the standard deviation of returns on each stock.
C. calculate the covariance and correlation between the returns on the two stocks.
Expected Return (Highbull) = .25x(-2) + .60x(9.02) + .15x(15.4)
= -0.50 + 5.412 + 2.31
= 7.22 %
Expected Return (Slowbear) = .25x(5) + .60x(6.2) + .15x(7.4)
The solution provides very good insight into how to calculate the expected return, standard deviation of a portfolio. It also shows calculations for covariance and correlation.