Question 3

Returns for the next period for the stocks of H Limited (H) and D. Inc (D) are given by the following probability distributions:

State of the Economy	Probability of State Occuring	Rate of Return H	Rate of Return D
Boom	0.30	5%	-15%
Normal	0.40	10	10
Recession	0.30	20	50

a. Calculate the expected rate of return for stock H, stock D, and a portfolio consisting of 60% H and 40% D.

b. Calculate the standard deviation for stock H, stock D, and the portfolio. Comparing the average of the individual stocks standard deviation with the portfolios standard deviation, what can we say about the correlation between the two stocks?