Reference no: EM132894010

The following table details an analyst's prediction of the probabilities of different states of the market over the next year, along with the forecast returns on security A and security B in each different market states given in the table below.

Securities                                                                  A                           B
A B Market States                   Probability            Return          Return
Very Good                                 0.2                 29%              14%
Good                                        0.4                13.5%            17.5%
Average                                    0.3                 11.5%           10.5%
Bad                                          0.1                  -8%                  3%

Problem (a) Calculate the expected returns and standard deviation of returns on security A and security B.

Problem (b) Calculate the covariance of returns between securities A and B.

Problem (c) Calculate the correlation co-efficient of securities A and B.

Problem (d) Discuss the importance of correlation co-efficient between returns of assets in forming a portfolio.