Problem 3: Expected Risk and Return

Consider a market with two securities, X and Y, whose expected returns over different states of the economy are provided below:

	Probability	Return for X	Return for Y
Boom	20%	40%	30%
Expansion	30%	20%	10%
Decline	40%	-5%	4%
Recession	10%	-45%	-10%

1. Calculate the expected return and standard deviation of security X and Y.

2. Knowing that the covariance between the two securities is equal to 0.02650, calculate the correlation between X and Y. How strong is the link between the two securities?

3. You create a portfolio containing 35% of Security X, 55% of Security Y, and the balance invested in a risk-free asset providing 2% return. Calculate the return and the volatility of this portfolio.

Note: Show your results using 6 decimal places