You are considering investing in two stocks with the unimaginative names stock X and stock Y. You believe that there are only three scenarios possible for the future and they can be labeled "bear market," "normal market," and "bull market." The table below shows the returns for the two stocks for these three scenarios and also shows the probability of each scenario occurring.
Bear Market Normal Market Bull Market
Probability .2 .5 .3
Stock X -20% 15% 50%
Stock Y -15% 10% 20%
4. What is the expected return for Stock X and Stock Y?
5. What is the standard deviation of returns for Stock X and Stock Y?
6. What is the covariance of Stock X and Stock Y?
7. What is the correlation coefficient of Stock X and Stock Y?
8. What is the expected rate of return on your portfolio if you invest $6,000 in Stock X and $4,000 in stock Y?
9. What is the variance in the returns of your portfolio with the 60%/40% proportion of question 8? What is the standard deviation?
10. Suppose that there is a safe asset that offers a return of 2% in all states of the world. What would be the expected rate of return and standard deviation of a portfolio that initially invested $5,000 in the safe asset, $3,000 is Stock X and $2,000 in Stock Y?
11. What is the slope of the Capital Asset Line (CAL) connecting the safe asset and the risky portfolio with 60% in Stock X and 40% in stock Y?
Expected Returns, Standard Deviations, Covariance and Correlation Coefficient are determined.