Chapter 7: Problems 3(a-d), 7(a-e), and 8

3. The following are the monthly rates of return for Madison Cookies and
for Sophie Electric during a six- month period.

Month Madison Cookies Sophie Electric

1 -0.04 0.07
2 0.06 -0.02
3 -0.07 -0.10
4 0.12 0.15
5 -0.02 -0.06
6 0.05 0.02

Compute the following.

a. Average monthly rate of return Ri for each stock

b. Standard deviation of returns for each stock

c. Covariance between the rates of return

d. The correlation coefficient between the rates of return-What level of

correlation did you expect? How did your expectations compare with the
computed correlation? Would these two stocks be good choices for
diversification? Why or why not?

7. The following are monthly percentage price changes for four market
indexes.

Month DJIA S&P 500 Russell 2000 Nikkei

1 0.03 0.02 0.04 0.04
2 0.07 0.06 0.10 -0.02
3 -0.02 -0.01 -0.04 0.07
4 0.01 0.03 0.03 0.02
5 0.05 0.04 0.11 0.02
6 -0.06 -0.04 -0.08 0.06

a. Average monthly rate of return for each index

b. Standard deviation for each index

c. Covariance between the rates of return for the following indexes:

DJIA S& P 500

 S& P 500Russell 2000

S& P 500Nikkei

Russell 2000Nikkei

d. The correlation coefficients for the same four combinations

e. Using the answers from parts ( a), ( b), and ( d), calculate the expected
return and stan-dard deviation of a portfolio consisting of equal parts of ( 1)
the S& P and the Russell 2000 and ( 2) the S& P and the Nikkei. Discuss the
two portfolios.

8. The standard deviation of Shamrock Corp. stock is 19 percent. The

standard deviation of Cara Co. stock is 14 percent. The covariance
between these two stocks is 100. What is the correlation between
Shamrock and Cara stock?