Question

                                                Norvell                                                                 Mullen

        Annual                                                         Annual

Date            Close Price     Dividend        Return(%)   Close Price     Dividend        Return(%)               

                                   

           

12/31/2014	24.00			28.00
12/31/2015	30.25	0.92	29.88	32.65	0.86	19.68
12/31/2016	27.50	1.12	-5.39	30.35	0.98	-4.04
12/31/2017	32.50	1.32	22.98	40.20	1.10	36.08
12/31/2018	29.90	1.52	-3.32	43.70	1.22	11.74
12/31/2019	35.20	1.72	23.48	40.50	1.34	-4.26

                       

Estimated s_Norvell = 16.56%                            Estimated s_Mullen = 17.03%

1. Compute the annual returns for 2015 through 2019 (e.g., each year's return) of an equally weighted portfolio of Norvell stock and Mullen stock.

2. Provide an intuitive explanation of what the correlation coefficient between the returns of the two securities measures. Comment on whether you would expect the typical correlation coefficient between two stocks to be positive, negative, or around zero, and why in either case.

Answer 1

Last column highlighted in yellow shows the annual returns for 2015 through 2019 (e.g., each year's return) of an equally weighted portfolio of Norvell stock and Mullen stock.

Date	Norvell Return	Mullen Return	Portfolio return
31-Dec-14	R1	R2	0.5 x (R1 + R2)
31-Dec-15	29.88	19.68	24.78
31-Dec-16	-5.39	-4.04	-4.72
31-Dec-17	22.98	36.08	29.53
31-Dec-18	-3.32	11.74	4.21
31-Dec-19	23.48	-4.26	9.61

Provide an intuitive explanation of what the correlation coefficient between the returns of the two securities measures.

A correlation coefficient is a statistical measure that explains to what extent the returns of two securities are related. To what extent their returns move together. Thus correlation coefficient is a measure of strength of relationship between the returns of two secueities.

Comment on whether you would expect the typical correlation coefficient between two stocks to be positive, negative, or around zero, and why in either case.

If the returns of the securities move in opposite direction, that is when one stock price rises, that of other one falls, and vice versa, then the correlation coefficient between the two stocks will be negative.

If the returns of the securities move in same direction, that is when one stock price rises, that of other one also rises; or the other way round, then the correlation coefficient between the two stocks will be positive.

If the returns of the securities are unrelated, then the correlation coefficient between the two stocks will be zero.