A. Covariance between securities

B. Correlation coefficient between securities

C. Variance of a portfolio

D. Standard deviation of a portfolio

E. Compare the standard deviation of individual securities with the portfolio standard deviation. Do you see diversification effect? (Standard deviation of individual securities = A = 25.86% and B = 11.5%)

Calculate the followings and verify the diversification effect with the data in the table assuming that with the initial endowment of $10,000, you invest $6,000 in Stock A and $4,000 in Stock B. Also four states of the economy are assumed to be equally likely. State of the Economy Return on Stock A Return on Stock B pression -20% 5% Recession 10% 20% Normal 30% -12% Boom 50% 9%