You have estimated the returns of 2 companies for the next year depending on the general economic condition.
Outcome Probability Company 1 Company 2
Boom 30% 15% 5%
Normal 50% 5% 0 Recession 20% 0% 10%
(A) Calculate the covariance and correlation between the returns of these 2 companies. (c) Let’s combine these 2 companies 50%-50% in portfolio P. Calculate the expected return and the standard deviation of the portfolio P. (d) Using mean-variance criterion, does any of the 3 investments, company 1, company 2, and portfolio P, dominate the other one.