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.

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter10: Forecasting Financial Statement

Section: Chapter Questions

Problem 7QE

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