E370

Week 05
Part 4:
Practice with Adding
Random Variables
 IBM stock has an expected value of
$91.40 and a standard deviation of
$2.22. Microsoft stock has an expected
value of $29.20 and a standard
deviation of $0.83. A portfolio consists
of 2 shares of each stock. Write the
formula for the total value of the
portfolio.
What is the expected value of the
portfolio?
What is the expected variance in value
of the portfolio, assuming the stocks
are unrelated?
A portfolio example
The stocks have a correlation
coefficient of 0.95. Given this
additional information, how would your
 TVP=2I + 2M

E(TVP)=E(2I + 2M) = 2*E(I) + 2*E(M) =

2*(91.40)+2*(29.20) = 182.80 + 58.40 =
$241.20

V(TVP)=V(2I + 2M) = 22*V(I) + 22*V(M)

= 4*V(I) + 4*V(M) = 4*4.9284 + 4*0.6889
= 19.7136 + 2.7556 = 22.4692

sTVP = SQRT(22.4692) = 4.74

Statistics


Covariance Term:

TotalVariance: 22.4692 + 14.00 =

36.4692

stvp= SQRT(36.4392) = 6.04

How do we use the correlation?

 Mr.Tippler of the Teetotal party
presented us with a linear
combination of random variables with
respect to trade between the US and
Barbados: Xn = X M. X is exports
of US goods to Barbados; M is imports
of Barbados goods by US; Xn is net
exports. Tippler's investigations have
Variabl information:
yielded the following Mea St
e n Dev
Imports
200 30
(M)
Net Exports, Xn
Exports
(X) 75 25
 According to Tippler, what is expected net
exports?
E(Xn)= E(X) E(M) = 75-200 = 125
What is the variance of net exports,
assuming X and M are independent?
V(Xn)= V(X M) = V(X) + V(M) = 252 + (30)2
=1525
Are X and M independent?
Tippler discovered that the correlation
coefficient between X and M is -0.50. Does
this change the variance in the previous
question? If so, by how much? If not, why
not?

Questions
r
= 0.50
Yes
If r = 0.50

The covariance term:

Total variance:
Standard Deviation of Xn=
SQRT(2275) = $47.70

So, are X & M Related?