Suppose the rates of return of the bond portfolio in the four scenarios of Spreadsheet 6.1 are −10% in a severe recession, 10% in a mild recession, 7% in a normal period, and 2% in a boom. The stock returns in the four scenarios are −37%, −11%, 14%, and 30%. What are the covariance and correlation coefficient between the rates of return on the two portfolios?

Spreadsheet 6.1

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A 2 Scenario 3 Severe recession 4 Mild recession 5 Normal growth B Probability 0.05 0.25 0.40 0.30 6 Boom 7 Expected or Mean Return: Stock Fund Rate of Return -37 -11 14 30 SUM: D Col B x Col C -1.9 -2.8 5.6 9.0 10.0 E Rate of Return -9 15 585 Bond Fund -5 SUM: Col B x Col E -0.45 3.8 3.2 -1.5 5.0