The following table lists possible rates of return on Company A and B. Probability Company A State of the Economy Deep recession 0.05 -20% Mild recession Average Mild boom Strong boom ii. 0.25 0.35 0.20 0.15 iii. 0 10 15 30 (a) Based on the above data calculate by using the appropriate formulae i. the standard deviations of returns for Company A and B the covariance of returns between Company A and B Company B -40% the correlation between Company A and B 10 0 25 30 (b) If you wish to diversify risk would it be advisable to form a portfolio of both securities A and B? State your reasons. (No computations are required to answer this part of the question.) (c) Find the minimum variance one can get by forming a portfolio of A and B. Short- selling either stock is allowed - i.e., weights need not be all positive.
The following table lists possible rates of return on Company A and B. Probability Company A State of the Economy Deep recession 0.05 -20% Mild recession Average Mild boom Strong boom ii. 0.25 0.35 0.20 0.15 iii. 0 10 15 30 (a) Based on the above data calculate by using the appropriate formulae i. the standard deviations of returns for Company A and B the covariance of returns between Company A and B Company B -40% the correlation between Company A and B 10 0 25 30 (b) If you wish to diversify risk would it be advisable to form a portfolio of both securities A and B? State your reasons. (No computations are required to answer this part of the question.) (c) Find the minimum variance one can get by forming a portfolio of A and B. Short- selling either stock is allowed - i.e., weights need not be all positive.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:The following table lists possible rates of return on Company A and B.
State of the Economy
Probability
Company A
Deep recession
0.05
-20%
Mild recession
Average
Mild boom
Strong boom
ii.
0.25
0.35
0.20
0.15
iii.
0
10
15
30
(a) Based on the above data calculate by using the appropriate formulae
the standard deviations of returns for Company A and B
i.
the covariance of returns between Company A and B
Company B
-40%
the correlation between Company A and B
10
0
25
30
(b) If you wish to diversify risk would it be advisable to form a portfolio of both
securities A and B? State your reasons. (No computations are required to answer
this part of the question.)
(c) Find the minimum variance one can get by forming a portfolio of A and B. Short-
selling either stock is allowed - i.e., weights need not be all positive.
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