State Probability Return: Stock 1 Return: Stock 2

Bear 0.25 -0.020 0.034

Normal 0.60 0.138 0.062

Bull 0.15 0.218 0.092

a) Calculate the covariance of return between Stock 1 and Stock 2

b) Calculate the correlation of return between Stock 1 and Stock 2.

c) If you combine Stock 1 and Stock 2 into a portfolio, will you obtain diversification benefits? Why, or why not (be sure to provide quantitative justification for your answer)?

d) What is the variance of return for a portfolio that invests 40% of wealth in Stock 1 and 60% in Stock 2.