Suppose you have two assets, A and B. A has returns of 10%, 2%, and 15%, with probabilities 40%, 50%, and 10% respectively. B has returns of 5%, 10%, and -
20%, with probabilities 40%, 50%, and 10% respectively. What is the return covariance between assets A and B?
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A. B. C. D.D
First we must find the expected returns for A and B. These are 6.50% and 5.00%, respectively. Second, we find the difference between each observation and the average: (10% - 6.5%), (2% - 6.5%), and (15% - 6.5%) for A, and (5% - 5%), (10% - 5%), and (-20% - 5%) for B. Next, we take the probability weighted cross product of these differences and sum them. So we get 3.5% * 0% * 40% + (-4.5%) * 5% * 50% + 8.5% * (-25%) * 10% = -32.45%%.