Can anyone please tell me how to solve this question… i know it is simple just i dont know how to get the correlation of coeff bet the two assets from their correlation of coeff with markets ?? Grover Clark, an analyst at Gypum Securities, compiled the following information about two securities, Forest Cutters, Inc. (FCT) and Peerless Industries (PRL): FCT PRL Stock Price 50.00 120.00 Dividend per share 2.00 3.00 Expected Growth Rate 5% 6% Standard Deviation of Returns 25% 30% Correlation of Returns with the Stock Market’s Returns .90 .70 Grover also observes that the risk-free interest rate is currently equal to 3%. The consensus expectation is that the general stock market will produce an 8% return over the long run and the historical standard deviation in the stock market’s return has been, and is expected to remain at 20%. From this information, Grover would like to understand something about other characteristics of these two stocks and how they would behave if combined into a portfolio. The standard deviation of the return for a $100,000 portfolio consisting of $50,000 of FCT and $50,000 of PRL is closest to: 1. 24.85% 2. 55.00% 3. 27.56%
I’ll give this a bump. We know it’s a port. standard deviation question, but how do we find the market cov. or correlation based on the information given?
I thought I had something, but I’m getting betas of over 20 and got discourage. Here’s what I was trying to accomplish: 1- Expected return for each stock. I’m thinking the CAPM approach can be used here since all the ingredients are given to calc beta. Beta is covariance of stock and market over variance of market. so .9/(.2^2) but this is equating to something like 22.5 for a beta. Is that 20% supposed to be the variance, not the standard deviaton? From there I was going to calc expected returns for the two stocks. 2. Then you’ll need to calculate the actual returns of the two stocks using the growth rates given. 3. Covariance = (Return1-Expected Return1)(Return2-Expected Return2)/n-1 That’s as much effort as I can put in before I shut down for the day. Anyone else try to run with these ideas, or I might be totally off. BTW is that a Stalla question? I haven’t seen anything like that in all the Schweser questions I’ve done.
still working on it but try this: Beta of stk = correlation of stk wth market * (dev of stk/ dev of mkt)
beanz not following that logic. granted I wouldn’t be able to understand much of anything at this point. Looking at this on a macro level… is calculating beta an LOS? The corp finance book isn’t within reach and I’m super lazy at the moment.
i kept getting something like .18 so i let it be. i dont think there would be anything remotely this time intensive on sat. if there is i’ll come to your town and buy u a shot. @mcaval08 - the beta formulas i know are just the simple (cov i,mkt/ mkt variance), and the beta of an asset and project. i came across the formula above while doing questions and wrote it down. (not much help coz i still cant use it) o well
To me it seems like the question can be solved without any calculation. With a maximum correlation (+1) the portfolio standard deviation comes to 27.56%. But these two stocks even though are positively related dont have maximum correlation (for that their correlation with market should have been equal which is not the case here). Thus, the only possible answer in this question should be 24.85%. Sorry if I went out of topic.
r-man that doesnt give you the correlation between i and j. With the information given its not possible to calculate the covariance (and therefore the correlation) correctly. Remember cov(A,B) = E(AB) - E(A)*E(B) The information in the question does not give you anything that you can use to calculate E(AB). The way to to do this question is as kh.asif has done it. Get to the stage where you have the portfolio stdev in terms of corr(a,b) and see if any of the results are possible.
Ah i’ve just had a look at it, that concerns estimating correlation by assuming the securities are similarly related to the market. Also what it uses for bi and bj is not the correlation of the stocks return with the market.
Hy!!! welll It is a stalla question… And they mysteriously find out the coeffi bet the two securities as .63… I have no clue how… The answer is 24.85%. Probably I would also do something similar to that suggested by kh.asif… this is my best bet… I dont have a clue about the formula suggested by r-man … will dig into it and see… Moreover in this question there is no need for the betas…