Consider the following information on two stocks: P(State) Stock A Stock B Boom 20% 30% 25% Normal 30% 15% -5% Slow 40% -5% 5% Bust 10% -12% 0% A) Calculate the covariance(A,B). B) Calculate the correlation(A,B). C) Suppose you invest $60,000 into stock A, and $40,000 into stock B. Calculate the expected return of the portfolio. (Enter percentages as decimals and round to 4 decimals) D) Suppose you invest $60,000 into stock A, and $40,000 into stock B. Calculate the standard deviation of the portfolio. (Enter percentages as decimals and round to 4 decimals)
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider the following information on two stocks:
| P(State) | Stock A | Stock B | |
| Boom | 20% | 30% | 25% |
| Normal | 30% | 15% | -5% |
| Slow | 40% | -5% | 5% |
| Bust | 10% | -12% | 0% |
A) Calculate the covariance(A,B).
B) Calculate the correlation(A,B).
C) Suppose you invest $60,000 into stock A, and $40,000 into stock B. Calculate the expected return of the portfolio. (Enter percentages as decimals and round to 4 decimals)
D) Suppose you invest $60,000 into stock A, and $40,000 into stock B. Calculate the standard deviation of the portfolio. (Enter percentages as decimals and round to 4 decimals)
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