Essay Question #4:

You are given the following information regarding the historical returns on two assets, X and Y:

1.

Year
1

Investment X
5%

Investment Y
-3%

-10%

6%

3%

12%

16%

-6%

4%

2%

Calculate the Covariance of Investment X and Investment Y

Covariance
of X and Y

Formula

Calculation

Covariance =
(1/n)(xi xavg)(yi yavg)

2.

Calculate the Standard Deviation of Investment X and Investment Y

Standard
Deviation

Investment
X

Formula

Calculation

SDX =
[(xi xavg)2 / n]1/2

Investment
Y

3.

SDY =
[(yi yavg)2 / n]1/2

Calculate the correlation of Investment X and Investment Y

Correlation
of X and Y

Formula

Calculation

XY =
Covxy /(SDx)(SDy)

4.

Calculate the expected return and standard deviation of a portfolio consisting of 30% Investment X and 70% Investment Y.
Portfolio of
30% X and
70% Y

Expected
Portfolio
Return

Formula

Calculation

E(Rp) =
E(Rx)(%x) + E(Ry)(%y)

SDp =
Portfolio
Standard
Deviation

5.

[(%x)2(SDx)2 + (%y)2(SDy)2
+ 2(%x)(%y)(COVxy)]1/2

Explain why a portfolio consisting of 30% investment X and 70% investment Y produces a lower standard deviation than a
portfolio consisting of 70% Y and 30% risk-free asset.

Answer:

The above are the formula and templates posted on the course website. Below are the sample answer keys
from two of your fellow classmates (for your reference).