Chapter 11, Problem 26QAP

Summary Introduction

Adequate information:

Probability in Bear $\left({\text{P}}_{\text{Be}}\right)$ = 0.30

Probability in Normal $\left({\text{P}}_{\text{No}}\right)$ = 0.55

Probability in Bull $\left({\text{P}}_{\text{Bu}}\right)$ = 0.15

Expected return for Stock J in Bear $\left(\text{R}{\left(\text{J}\right)}_{\text{Be}}\right)$ = -0.050

Expected return for Stock J in Normal $\left(\text{R}{\left(\text{J}\right)}_{\text{No}}\right)$ = 0.118

Expected return for Stock J in Bull $\left(\text{R}{\left(\text{J}\right)}_{\text{Bu}}\right)$ = 0.274

Expected return for Stock K in Bear $\left(\text{R}{\left(\text{K}\right)}_{\text{Be}}\right)$ = 0.029

Expected return for Stock K in Normal $\left(\text{R}{\left(\text{K}\right)}_{\text{No}}\right)$ = 0.074

Expected return for Stock K in Bull $\left(\text{R}{\left(\text{K}\right)}_{\text{Bu}}\right)$ = 0.098

To compute: Expected return, standard deviation, covariance, and correlation.

Introduction: The expected return of the stocks refers to the return expected on the stocks. Standard deviation measures the deviation between the actual prices and the average price. Covariance reflects the relationship of two random variables and projects the impact of one variable whenever the other one changes. Correlation refers to the degree of fluctuation of two variables in relation to one another.