5-30E

a.

The correlation coefficient between random variable x and y is as follows:

 xy
 xy  (1)
 x y

Where,  xy is the covariance of random variable x and y;  x is standard deviation of x,

 y is standard deviation of y.

From information,

 xy  0.74,  x  19.45,  y  23.17

Substitute the values in equation (1) and obtain the covariance between S&P500 and
REITs. Therefore, the covariance is as follows:

 xy
0.74 
19.45 23.17 
 xy =  0.74 19.45  23.17 
= 333.486

Therefore, the required answers is: 333.486 .

From information,

 xy  0.04,  x  2.13,  y  23.17

Substitute the values in equation (1) and obtain the covariance between core bond and
REITs. Therefore, the covariance is as follows:

 xy
0.04 
 2.13 23.17 
 xy =  0.04  2.13 23.17 
= -1.974

Therefore, the required answers is: 1.974 .

b.

It is required to find the expected return for someone who invests 50% in S&P500 and
50% in REITs. Expected value of linear combination of random variables x and y is as
follows:

E (ax  by )  aE ( x)  bE ( y ) (2)

From information given,

E ( x)  5.04, E ( y )  13.07

Substitute the values in the equation 2 and obtain the required return. The required return
is as follows:

E (0.5 x  0.5 y )  0.5E ( x)  0.5E ( y )

= 0.5  5.04  +0.5 13.07 
= 9.055

Therefore, the required answer is: 9.06% .

The variance of linear combination of two random variables is as follows:

Var (ax  by)  a2Var ( x)  b2Var ( y)  2ab xy (3)

From information given,

Var ( x)  19.452 ,Var ( y)  23.172 ,  xy  333.486

Substitute the values in equation (3) and compute the variance of the return. The variance
is as follows:

Var (0.5x  0.5 y)  0.52 19.452   0.52  23.172   2  0.5 0.5 333.486 
= 395.53085

The standard deviation of the return is as follows:

SD(0.5 x  0.5 y )  Var (0.5 x  0.5 y )

= 395.53085
= 19.89
Therefore, the required answer is: 19.89% .

c.

It is required to find the expected return for someone who invests 50% in core bond and
50% in REITs.

From information given,

E ( x)  5.78, E ( y )  13.07

Substitute the values in the equation (2) and obtain the required return. The required
return is as follows:

E (0.5 x  0.5 y )  0.5E ( x)  0.5E ( y )

= 0.5  5.78  +0.5 13.07 
= 9.425

Therefore, the required answer is: 9.4% .

From information given,

Var ( x)  2.132 ,Var ( y)  23.172 ,  xy  1.974

Substitute the values in equation (3) and compute the variance of the return. The variance
is as follows:

Var (0.5x  0.5 y)  0.52  2.132   0.52  23.17 2   2  0.5  0.5  1.974 
= 134.35945

The standard deviation of the return is as follows:

SD(0.5 x  0.5 y )  Var (0.5 x  0.5 y )

= 134.35945
= 11.59

Therefore, the required answer is: 11.59% .

d.

It is required to find the expected return for someone who invests 80% in core bond and
20% in REITs.

From information given,

E ( x)  5.78, E ( y )  13.07

Substitute the values in the equation (2) and obtain the required return. The required
return is as follows:

E (0.8 x  0.2 y )  0.8E ( x)  0.2 E ( y )

= 0.8  5.78  +0.2 13.07 
= 3.076

Therefore, the required answer is: 3.08% .

From information given,

Var ( x)  2.132 ,Var ( y)  23.172 ,  xy  1.974

Substitute the values in equation (3) and compute the variance of the return. The variance
is as follows:

Var (0.8x  0.2 y)  0.82  2.132   0.22  23.17 2   2  0.8  0.2  1.974 
= 23.745892

The standard deviation of the return is as follows:

SD(0.8 x  0.2 y )  Var (0.8 x  0.2 y )

= 23.745892
= 4.87

Therefore, the required answer is: 4.87% .

e.

Aggressive investor would make investments in riskier portfolio, that has high standard
deviation of return and conservative investor would make investment in portfolios with
lesser standard deviation. Therefore, an aggressive investor would invest in portfolio
which comprises 50% in core bonds and 50% in REITs. This would give him 9.4% return
but second highest standard deviation of return that is 11.59%. A moderate investor
would invest in 80% core bond and 20% REITs. This would not yield much return, only
3.08%, but least risk with a standard deviation of 4.87%.