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Question - The Jones Company is looking to make an investment in some shares and other investments to diversify their portfolio. They are interested in the following two stocks and have been able to determine their expected returns based on the expected different states of the economy.
State of Economy
Probability
ABC Company Expected Return
DEF Company Expected Return
Very Good
0.20
40%
38%
Good
30%
24%
Average
0.30
20%
8%
Poor
10%
5%
Expected Return
23.00%
16.30%
Variance
0.016501
Required -
A) Calculate the variance of the returns of ABC Company.
B) Calculate the covariance of the expected returns of ABC Company and XYZ Company.
C) For two stocks when added to a portfolio to have diversification benefits the correlation coefficient between the stocks must be negative.
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