Question

The following are the monthly rates of return for Madison Cookies and for Sophie Electric during a six-month period. |

Month | Madison Cookies | Sophie Electric |

1 | -0.04 | 0.07 |

2 | 0.06 | -0.02 |

3 | -0.07 | -0.10 |

4 | 0.12 | 0.15 |

5 | -0.02 | -0.06 |

6 | 0.05 | 0.02 |

Compute the following: |

a. Average monthly rate of return, Ri, for each stock |

b. Standard deviation of returns for each stock |

c. Covariance between the rates of return |

d. The correlation coefficient between the rates of return |

What level of correlation would you have expected before performing your calculations? How did your expectations compare with the computed correlation? Would these two stocks be good choices for diversification? Why or why not? |

Step 1

**a.**

**Calculation of Average Monthly Rate of Return for each stock:**

The Average Monthly Rate of Return is calculated using an excel function =AVERAGE, which provides the average. **The excel spreadsheet with excel function is shown below:**

Step 2

**The excel spreadsheet with workings is shown below:**

Step 3

**b.**

**Calculation of Standard Deviation of Return for each stock:**

To calculate the standard deviation of each stock, it is required to calculate the variance for each stock. The variance is calculated using ...

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