Problem:
I need help to solve some problems from book Investment Analysis and Portfolio Management (9th ed.). FINANCE major. Book from: Frank K. Reilly, & Keith C. Brown, (2009). Mason, OH: South-Western/ Cengage Learning. Book used by Strayer University.
Please see the attachment:
1. Considering the world economic outlook for the coming year and estimates of sales and earnings for the pharmaceutical industry, you expect the rate of return for Lauren Labs common stock to range between –20 percent and +40 percent with the following probabilities:
Compute the expected rate of return E(R i) for Lauren Labs.
|
Probability
|
Possible Returns
|
|
0.10
|
-0.20
|
|
0.15
|
-0.05
|
|
0.20
|
0.10
|
|
0.25
|
0.15
|
|
0.20
|
0.20
|
|
0.10
|
0.40
|
2. 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 [E(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 did you expect? How did your expectations compare with the computed correlation? Would these two stocks offer a good chance for diversification? Why or why not?