FM11_Ch_05_Tool_Kit

# Third multiplythe previous product by the probability

This preview shows page 1. Sign up to view the full content.

This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: iplythe previous product by the probability of its occurrence. Fourth, find the some of all the weighted products. The result is the covariance. Calculation of covariance between F and G Probability of Occurrence Deviation of F from r hat Deviation of G from r hat Product of deviations Product * P rob. 10% 20% 4 0% 20% 10% 100% -4 % -2% 0% 2% 4% 4% 2% 0% -2% -4 % -0.1600% -0.04 00% 0.0000% -0.04 00% -0.1600% -0.02% -0.01% 0.00% -0.01% -0.02% Covariance = s um = -0.04 8% Calculation of covariance between F and H Probability of Occurrence Deviation of F from r hat Deviation of H from r hat Product of deviations Product * P rob. 10% 20% 4 0% 20% 10% 100% -4 % -2% 0% 2% 4% -6% -4 % -2% 5% 12% 0.24 00% 0.0800% 0.0000% 0.1000% 0.4 800% 0.02% 0.02% 0.00% 0.02% 0.05% Covariance = s um = 0.108% Calculation of covariance between F and E Probability of Occurrence Deviation of F from r hat Deviation of E from r hat Product of deviations Product * P rob. 10% 20% 4 0% 20% 10% 100% -4 % -2% 0% 2% 4% 0% 0% 0% 0% 0% 0.0000% 0.0000% 0.0000% 0.0000% 0.0000% 0.00% 0.00% 0.00% 0.00% 0.00% Covariance = s um = 0.000% CORRELATION COEFFICIENT Like covariance, the correlation coefficient also measures the tendency of two stocks to move together, but it is standardized and it is always in the range of -1 to +1. The correlation coefficient is equal to the covariance divided by the product of the standard deviations. Calculation of the correlation between F and G ρFG = Covariance FG = -0.04 8% = -0.04 8% ρFG = -1.0 SigmaF * SigmaG ÷ ÷ ÷ 2.19% 0.04 8% 2.19% Calculation of the correlation between F and H ρFH = Covariance FH = 0.108% = 0.108% ρFH = 0.935 ÷ ÷ ÷ SigmaF * SigmaH 2.19% 0.116% 5.27% PORTFOLIO RISK AND RETURN: THE TWO-ASSET CASE Suppose there are two assets, A and B. wA is the percent of the portfolio invested in asset A. Since the total percents invested in the asset must add up to 1, (1-w A) is the percent of the portfolio invested in asset B. The expected return on the portfolio...
View Full Document

## This document was uploaded on 01/20/2014.

Ask a homework question - tutors are online