Expected Return/Standard Deviation
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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.
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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.
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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)
...
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