CALCULATION OF COVARIANCE

Practical Problem on Co-variance:

Covariance = @

Illustration 1:

From the following information, calculate co-variance of a security with market.

Year Return on Security (%) Return on Market Portfolio (%)

1 10 12
2 12 11
3 15 14
4 10 12
5 8 11
Solution:

Year @ @ @ @ @
1 10 12 -1 0 0
2 12 11 1 -1 -1
3 15 14 4 2 8
4 10 12 -1 0 0
5 8 11 -3 -1 3

55 60 10

@ = 11

@ = 12

@ =2.5

Illustration 2:

Calculate co-variance in case of share of Sonu Ltd., whose return and market portfolio return on
given below:

Year Return on Sonu Ltd. Market Portfolio Return

1 20 14
2 24 18
3 10 9
4 15 14
5 (10) (8)
6 12 10
7 18 16
8 28 30
9 33 35
 10 40 42

Solution:

Year @ @ @ @ @

1 20 14 1 (4) (4)
2 24 18 5 0 0
3 10 9 (9) (9) 81
4 15 14 (4) (4) 16
5 (10) (8) (29) (26) 754
6 12 10 (7) (8) 56
7 18 16 (1) (2) 2
8 28 30 9 12 108
9 33 35 14 17 238
10 40 42 21 24 504
190 180 1,755
@ = 19 @ = 18

@ = 195

Illustration 3:

From the following detail calculate co-variance.

Year Return on Security (%) Return on Market Portfolio(%)

1 10 12
2 12 10
3 13 10
4 10 12
5 8 15
6 11 14
7 16 20
8 12 15
9 18 20
10 20 22

Solution:

Year @ @ @ @ @

1 10 12 -3 -3 9
2 12 10 -1 -5 5
3 13 10 0 -5 0
4 10 12 -3 -3 9
5 8 15 -5 0 0
 6 11 14 -2 -1 2
7 16 20 3 5 15
8 12 15 -1 0 0
9 18 20 5 5 25
10 20 22 7 7 49

130 150 114

@ = 13 @ = 15

@ = 12.66

Illustration 4:

Calculate Co-variance of A Ltd. & B Ltd., from the following information.

Year Return of A Return of B Market

Ltd. (%) Ltd. (%) Return (%)

1 20 19 20
2 18 16 17
3 16 12 14
4 21 19 20
5 24 23 24
6 28 25 27
7 22 20 21
8 20 19 20

Solution:

A L td.

Year @ @ @ @ @

1 20 20 -1.125 -0.375 0.4219

2 18 17 -3.125 -3.375 10.5469
3 16 14 -5.125 -6.375 32.6719
4 21 20 -0.125 -0.375 0.0469
5 24 24 2.875 3.625 10.4219
6 28 27 6.875 6.625 45.5469
7 22 21 0.875 0.625 0.5469
8 20 20 -1.125 -0.375 0.4219

169 163 100.625

 @ = 21.25 @ = 20.375

@ = 14.375

B Ltd.

Year @ @ @ @ @

1 19 20 -0.125 -0.375 0.0469

2 16 17 -3.125 -3.375 10.5469
3 12 14 -7.125 -6.375 45.4219
4 19 20 -0.125 -0.375 0.0469
5 23 24 3.875 3.625 14.0469
6 25 27 5.875 6.625 38.9129
7 20 21 0.875 0.625 0.5469
8 19 20 -0.125 -0.375 0.0469

153 163 109.616

@ = 19.125 @ = 20.375

@ = 15.66

Illustration 5:

From the following you are expected to calculate.

(I) Expected return of security.

(II) Measure of total risk (standard duration).
(III) Co-efficient of co-variance.

Year Return of A Ltd. (%) Return of B Ltd. (%) Market Return (%)

1 8 7 8
2 9 11 11
3 10 9 10
4 11 13 13
5 12 15 12

50 55 54
Solution:

(I) Calculation of expected return.

@ = 10

@ = 11

@ = 10.8

(II) Calculation of standard deviation.

Year @ @ @ @ @ @
1 8 -2 4 7 -4 16
2 9 -1 1 11 0 0
3 10 0 0 9 -2 4
4 11 1 1 13 2 4
5 12 2 4 15 4 16

50 10 55 40

=11

Selected deviation =@

𝜎 Of A Ltd. =@

= 1.581

𝜎 of B Ltd. =@

= 3.162

(III) Calculation of Co-variance between @ and @

Year @ @ @ @ @
1 8 8 -2 -2.8 5.6
2 9 11 -1 0.2 -0.2
3 10 10 0 -0.8 0
4 11 13 1 2.2 2.2
5 12 12 2 1.2 2.4
 50 54 10

@ = 10 @ = 10.8

@ = 2.5

(IV) Calculation of Co-variance between @ and @

Year @ @ @ @ @
1 7 8 -4 -2.8 11.2
2 11 11 0 0.2 0
3 9 10 -2 -0.8 1.6
4 13 13 2 2.2 4.4
5 15 12 4 1.2 4.8

55 54 22

@ = 11

@ = 10.8

@ = 5.5