E120

Homework 8
Due 11/14/2014
1. A die is rolled twice. Let X equal the sum of the outcomes, and let Y equal the first
outcome minus the second.
(a) Are X and Y independent random variables?
(b) Compute Cov(X,Y).
Note: We know that X and Y being independent implies Cov(X, Y ) = 0. This
problem shows the converse is not true, i.e. Cov(X, Y ) = 0 does not imply X and
Y are independent.
2. You are playing a normal game of roulette. Let X denote the winnings when placing an
Even bet (you win $1 if the ball lands in one of the 2, 4, ..., 36 pockets). Let Y denote
the winnings when placing an Odd bet. Let Z denote the winnings when placing a 00
bet (you win $35 if the ball lands in the 00 pocket). Let W denote the winnings when
placing a 1 bet (you win $35 if the ball lands in the 1 pocket).
(a) Find Cov(X,Y).
(b) Find Cov(X,Z).
(c) Find Cov(X,W).
(d) Find Cov(Y,W).
Note: there are a total of 38 pockets on a roulette wheel, numbered 1, . . . , 36, 0, 00.
3. The expected returns and variances (of returns) for two assets are:
ASSET RETURN VARIANCE
1
0.10
0.04
2
0.15
0.09
The correlation between the returns is 12 = 0.20. Note that AB =

Cov(A,B)

V ar(A)

V ar(B)

(a) Calculate the portfolio expected return and variance for the weights (0.2, 0.8);
that is, invest 0.2 in asset 1, and invest 0.8 in asset 2.
(b) Calculate the portfolio expected return and variance for the weights (0.5, 0.5).
(c) Give the portfolio (consisting of the above two assets) which has an average return
of 0.12. What is the variance of that portfolio?
(d) Give a portfolio (consisting of the above two assets) which has a variance of 0.16.
(e) Suppose you can only invest in the above risky assets, what weights will yield a
minimum-variance portfolio? What is the variance of return for this portfolio?