Question 1 :

Calculate the following:

1. covariance between Stock Y's and Stock Z's returns. 

2. correlation between Stock Y's and Stock Z's returns. 

3. variance on a portfolio that is made up of equal investments in Stock Y and Stock Z stock. 

4. Briefly explain why the covariance of a security with the rest of a well-diversified portfolio is a more appropriate measure of the risk of the security than the security's variance. 

5. If a portfolio has a positive investment in every asset, can the standard deviation on the portfolio be less than that on every asset in the portfolio? What about the portfolio beta?

6. Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the expected return on such an asset? Is it possible that a risky asset could have a negative beta? What does the CAPM predict about the expected return on such an asset? Can you give an explanation for your answer?
 

Consider the following returns: Year End 2004 2005 2006 2007 2008 2009 Stock X Realized Return 20.1% 72.7% -25.7% 56.9% 6.7% 17.9% Stock Y Realized Return -14.6% 4.3% -58.1% 71.1% 17.3% 0.9% Stock Z Realized Return 0.2% -3.2% -27.0% 27.9% -5.1% -11.3%