Mod 3: P2

The goal of this project is to explore the topics of covariance and correlation. The project requires you to work in Excel with the provided spreadsheet. Be sure to fill in the yellow boxes in the Excel file for full credit and show all work by referencing cells where necessary (do not simply type in answers). In addition, type up a report in Word (1-2 pages) with a separate section for the introduction (description of the project), findings (answer assignment questions, plots, etc.), and conclusion (conclusions, summary). Make sure to follow all directions or points will be deducted.

FINC 6366

Project 2

Covariance and Correlation

The goal of this project is to explore the topics of covariance and correlation. The project requires you to work in Excel with the provided spreadsheet. Be sure to fill in the yellow boxes in the Excel file for full credit and show all work by referencing cells where necessary (do not simply type in answers). In addition, type up a report in Word (1-2 pages) with a separate section for the introduction (description of the project), findings (answer assignment questions, plots, etc.), and conclusion (conclusions, summary). Make sure to follow all directions or points will be deducted. This is an individual project so be sure to submit your own work. Upon completion, please submit both your Word report and Excel file to blackboard at the same time. Each question (A, B, C, D, E) in the Excel file is worth 18 points (total of 90 points) and the report is worth 10 points.

Covariance and Correlation

The following table shows the expected returns from six different stocks in three different states of the economy:

State of Economy

Probability

Return Stock A

Return Stock B

Return Stock C

Return Stock D

Return Stock E

Return Stock F

Growth

0.25

31%

3%

15%

21%

0%

18%

Status Quo

0.50

21%

1%

3%

7%

4%

3%

Recession

0.25

20%

4%

-5%

-6%

6%

-4%

A) Calculate the expected return for each stock. (18 Points)

B) Calculate the standard deviation for each stock. (18 Points)

C) Consider of a portfolio consisting of 50% in Stock A and 50% in Stock B. Calculate the covariance between Stocks A and B. Calculate the expected return of the portfolio. Calculate the standard deviation of the portfolio. (18 Points)

D) Consider of a portfolio consisting of 50% in Stock C and 50% in Stock D. Calculate the covariance between Stocks C and D. Calculate the expected return of the portfolio. Calculate the standard deviation of the portfolio. (18 Points)

E) Consider of a portfolio consisting of 50% in Stock E and 50% in Stock F. Calculate the covariance between Stocks E and F. Calculate the expected return of the portfolio. Calculate the standard deviation of the portfolio. (18 Points)

In your report, for each portfolio describe the correlation between the two stocks. In addition, describe the impact on risk of including the two stocks in a portfolio. Use the formulas below in your Excel calculations.

Formulae:

;

;

FINC 6366 – Project 2

21% 1% 3%

3%

0.25

4%

6%

FINC 6366 – Project 2 – Covariance and Correlation

Name

Alexis

Giusti

State of Economy

Probability

Return for Stock A

Return for Stock B

Return for Stock C

Return for Stock D

Return for Stock E

Return for Stock F

Growth

0.25

3

1%

3%

15%

21%

0%

18%

Status Quo

0.50

7%

4%

Recession

20%

-5%

–

6%

-4%

A) Expected Returns

E[RA]

E[RB]

E[RC]

E[RD]

E[RE]

E[RF]

B) Standard Deviations

σA

σB

σC

σD

σE

σF

C) Portfolio AB

WA

WB

CovAB

CorrAB

E[RAB]

σAB

D) Portfolio CD

WC

WD

CovCD

CorrCD

E[RCD]

σCD

E) Portfolio EF

WE

WF

CovEF

CorrEF

E[REF]

σEF