Suppose there are three states of the world, which are all equally likely, and two different financial assets. In the first state of the world, the first asset returns 8% and the second asset returns −5%. In the second state, the first asset returns −4% and the second asset returns 15%. In the third state, the first asset returns 12% and the second asset returns 6%.

a) What is the mean return on each asset? What is the variance and standard deviation of the return on each asset? Use natural units, not percentages (i.e., use 0.09 instead of 9 for 9% ).

b)What is the covariance of the returns of the two assets? What is the correlation between the two returns?

c) Consider an equal weighted portfolio of the two assets. Compute the mean return, variance and standard deviation.

Answer rating: 100% (QA)

a The mean return on the first asset is 008 004 0123 0053 or 53 The mean return on the second asset ... View the full answer