The components of two portfolios have the following random returns and correspon

Question

The components of two portfolios have the following random returns and corresponding probabilities:

         Pr                   A/B

Port A

Port B

   Stock                 0.2/ 0.25

5000

1500

    Bond                 0.3 /0.25

3000

2000

Treasury Bond      0.5/0.5

1000

1000

Estimate the correlation coefficient for both portfolios

         Pr                   A/B

Port A

Port B

   Stock                 0.2/ 0.25

5000

1500

    Bond                 0.3 /0.25

3000

2000

Treasury Bond      0.5/0.5

1000

1000

Explanation / Answer

Correlation between two portfolios is 0.50

50% strength of a linear relationship between two portfolios

    Pr                   A/B Port A Port B     Stock                 0.2/ 0.25                         5,000     1,500      Bond                 0.3 /0.25                         3,000     2,000 Treasury Bond      0.5/0.5                         1,000     1,000 CORREL(B2:B4,C2:C4) 0.50

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