Stock A is expected to return 14 percent in a normal economy and lose 21 percent in a recession. Stock B is expected to return 11 percent in a normal economy and 5 percent in a recession. The probability of the economy being normal is 75 percent with a 25 percent probability of a recession. What is the covariance of these two securities?a) 0.007006b) 0.006563c) 0.005180d) 0.007309e) 0.006274

The correct option is b) 0.006563.

Explanation:

Note: See the attached excel file for the calculation of the covariance between stocks A and B.

Covariance refers to a metric that measures the relationship between two random variables by showing the degree to which the two variables change together.

A positive covariance means that two variables move in the same direction, while a negative covariance indicates that the two variables tend to move in the opposite directions.

In the attached excel file, the following are used:

RA = Rate of Return of Stock A

RB = Rate of Return of Stock B

P = Probability

ERA = Expected return of Stock A = RA * P

ERB = Expected return of Stock B = RB * P

DA = Deviation of Stock A = RA - Sum of ERA

DB = Deviation of Stock B = RB - Sum of ERB

N = Number of observation = 2

Therefore, Covariance of Stock A and B is calculated using the covariance formula as follows:

Covariance of Stock A and B = Sum of (DA * DB) / N = 1.3125% / 2 = 0.6563%, or 0.006563

Therefore, the covariance of these two securities is 0.006563. This shows that the correct option is b) 0.006563.

in 2001, dell computer became the world’s largest personal computer vendor, continuing to

gain market share and post profits in an industry struggling with slumping sales and billions of

dollars in losses. dell sells 90% of its pcs directly to the final customer, largely bypassing the

reseller channel that accounts for most of the world’s pc sales. this direct customer relationship

is the key to dell’s business model, and provides distinct advantages over the indirect sales

model. dell’s direct relationship with the customer allows it to tailor its offerings to customer

needs, offer add-on products and services, and use the internet to offer a variety of customer

services. in addition, dell’s pcs are built to customers’ specifications upon receipt of an order,

giving dell additional advantages over indirect pc vendors who must try to forecast demand and

ship products based on those forecasts. dell’s direct sales and build-to-order model has achieved

superior performance in the pc industry in terms of inventory turnover, reduced overhead, cash

conversion, and return on investment (kraemer, et al., 2000).

explanation:

d. low interest rates