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Expected Return/Standard Deviation

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.

Solution Preview

Answer (a):
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)

Solution Summary

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.