You have invested in two projects that next period are expected to yield cash flows of respectively NOK 12,000 (project 1) and NOK 8,000 (project 2). These cash flows are, however, uncertain. You have estimated their standard deviations to be NOK 14,000 (project 1) and NOK 6,000 (project 2). Based on previous experience you assume that the correlation coefficient between the two cash flows is 0.4. what willl be the expected cash flow for project A and B ?
E(A+B) = E(A) + E(B) = 12,000 + 6,000 = 20,000 StDev(A+B) = sqrt(StDev(A)^2 + StDev(B)^2 + 2*StDev(A)*StDev(B)*Correl(A,B)) = 17,297 (approx) The expected cash flow is 20,000
Dont you need the weights of the 2 projects? “what willl be the expected cash flow for project A and B ?” --by this, you’re asking what’s the expected return of a portfolio containing project A and B right?
yeah its the same way liaaba its just thats its no probab or weights specified … thanks much for the answer maratikus !! have a great day
supersunny138 Wrote: ------------------------------------------------------- > yeah its the same way liaaba its just thats its no > probab or weights specified … thanks much for > the answer maratikus !! have a great day —it’s not right without the weights or the probs…the whole point of having the weights and the probs is so that they sum to 1…the calculation above, basically a weight of 1 is given to each… you can assume equal weights or prob and use 0.5 for both, but using 1 for both is definitely not right…
Nah, I’m with Maratikus on this (which, btw, is a pretty good place to be).
>E(A+B) = E(A) + E(B) = 12,000 + 6,000 = 20,000 E(B) = 8000 => E(A)+E(B) = 22,000 standard deviation/correlation are a red herring.
Could someone explain why the weigths were not needed for the above problem? and how do we identify, when to use weights and when not to use them? If weights are not given, is it safe to assume them to be 1 (as done to solve the above problem), ideally it should have been Weight of project A = Wa = 0.5 Weight of project B = Wb = 0.5 …and then solved accordingly Please let me know what am I missing? - Dinesh S
You have invested in two projects with expected cash flows of [blah] means that the expected cash flows are to you. These are just one set of cash flows. There might be lots more cash flows, you might be getting all or part of the cash flows from the whole project, there might be other investors, you might have paid 100X more for one than the other (because there are other cash flows coming later), etc…
surely the “weights” are just defined by the size of the cash flows? We’d only need weights in this question if you were given IRRs instead of actual cash flows.
Chrismaths i didnt understand … if the expected cashflow of the both projects is 20,000 (E(A)12,000 +E(B) 8000) – (above u got 12+6 = 20 ) , how did u get theE(A)+ E(B) = 22000 tks
it was my typo. it should’ve been E(A) + E(B) = 12,000 + 8,000 = 20,000