Question
Suppose we have the expected daily returns (in terms of U.S. dollars), standard deviations, and correlations shown in the table below. U.S., German, and Italian
Suppose we have the expected daily returns (in terms of U.S. dollars), standard deviations,
and correlations shown in the table below.
U.S., German, and Italian Bond Returns
U.S. Dollar Daily Returns in Percent
U.S. Bonds German Bonds Italian Bonds
Expected Return 0.029 0.021 0.073
Standard Deviation 0.409 0.606 0.635
Correlation Matrix
U.S. Bonds German Bonds Italian Bonds
U.S. Bonds 1 0.09 0.10
German Bonds 1 0.70
Italian Bonds 1
Source: Kool (2000), Table 1 (excerpted and adapted).
Q: State the expected return and variance of return on a portfolio 70 percent invested in U.S. bonds, 20 percent in German bonds, and 10 percent in Italian bonds.
I know the answer is as follow.
Expected Return (.70)(.029) + (.02)(.021) + (.1)(.073) = .0318
Variance of Return Square the Standard Dev. US = (.409) = 0.167281 German = (.606) = 0.367236 Italian = (.635) = 0.403225 (.70)(.167281) + (.02)(.367236) + (.1)(.403225) + 2(.70)(.20)(.022307) + 2(.70)(.10)(.025972) + 2(.20)(.10)(.26967) = .121346
But I didn't understand the last equation. Why do we need to square 0.7, 0.02 and 0.1 in it?
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