Skip to main content

How to calculate Standard Deviation of two stocks?

 Portfolio correlation:
The correlation states that how much one stock is related to other stock. It measure on the scale of +1.0 to -1.0. If the two stocks have +1 correlation it means both the stocks are positively correlated and if the return of one stock decreases then the return of other stock also decreases in same manner. If both the stocks have 0 correlations it means the two stocks are not correlated it means the return of one stock is increases the other stock does not show the same effect. If the two stocks have -1 correlation it means they are negative correlated and if the return of one stock increases then the return of other stock decreases. Correlation shows the degree of relationship between two stocks.

Formula:
Rij = covij / σi σj
Where,
covij = co-variance between stock i and j
σi = standard deviation of asset i
σj = standard deviation of asset j

Portfolio Co-variance: The co-variance states that how two stocks price move in future. If two stocks move in same direction it means the two stocks have positive co-variance. The negative co-variance means the two stocks move in opposite direction. The investors want to invest in those stocks which have negative co-variance which help to reduce the risk level.

Formula:
Co-variance =Æ© (returni –Averagei)*(Returnj – Averagej) / Sample size – 1
OR
Co-variance = pij * σi *σj

Standard deviation of two stocks portfolio: Standard deviation shows the risk level of two stocks.
Formula:
σp = √(wi2 σi2 + wj2 σj2 + 2wi wj covij)
or
σp = √(wi2 σi2 + wj2 σj2 + 2wi wj σi σj pij)
Where,
σp = standard deviation of portfolio
wi and wj = weight of security i and j
pij = correlation of security i and j

Example: Suppose Mr. Y has invested in two companies stock that is AB Company and MN Company. Find out the co-variance between AB stock and MN stock.

Stock
Standard deviation
Correlation of stock AB and MN
AB stock
21%
0.25
MN stock
28%





Solution:
Co-variance =pij * σi *σj
= 0.25*21*28
= 1.47
It shows positive co-variance means both stocks prices were move in same direction.

Example: Find out the Correlation if stock A has 24% and stock B has 32% standard deviation. The co-variance between two stocks is 0.18.

Solution: Rij = covij / σi σj
= 0.18 / 24*32
= 0.000234%
It shows zero correlation between AB stock and MN stock. So, there is no relationship between these two stocks.

Example: Find out the standard deviation of two stocks with the help of given information:
Stock
Weight of stock
Standard deviation
A
60%
52%
B
40%
45%
 The correlation of stock A and B is 0.32.

Solution:
σp = √(wi2 σi2 + wj2 σj2 + 2wi wj σi σj pij)
= √ (0.602 *522 + 0.402 *452 + 2*0.6 *0.4*52*45*0.32)
= √ (0.36*2, 704 + 0.16*2, 025 + 0.48*748.8)
= √ (973.44 + 324 + 359.42)
= √1, 656.86
= 40.70%

Example: Mr X has invested in stock C and D. The weights of security C and D in a portfolio is 30% and 70% respectively. The co-variance of stock C and D is 0.18. The standard deviation of stock C and D is 26% and 38% respectively. Find out the standard deviation of a portfolio.

Solution:
σp = √(wi2 σi2 + wj2 σj2 + 2wi wj covij)
= √ (0.32*262 + 0.72*382 + 2*0.3*0.7*0.18)
= √ (0.09*676 + 0.49*1, 444 + 0.42*0.18)
= √ (60.84 + 707.56 + 0.0756)
= √ 768.48
= 27.72%




Comments

  1. Phani KumarJune 23, 2020 2:50 pm

    Hey, thanks for the information. your posts are informative and useful. I am regularly following your posts.
    Best stocks,
    La Opala RG,
    GM Breweries,
    IG Petrochemicals,
    CDSL Ltd,

    ReplyDelete
  2. DariyaJune 28, 2020 4:42 pm

    Nice article thanks for sharing such a valuable information with us.you may also check our blog for more information Stock market

    ReplyDelete

Post a Comment

Popular posts from this blog

How to calculate Cost of Preference Share Capital?

Cost of Preference Share Capital:  An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital. Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt. Formula for Cost of Preference Share: Irredeemable Preference Share Redeemable Preference Share K p  = Dp/NP K p  = D p +((RV-NP)/n )/ (RV+NP)/2 Where, K p  = Cost of Preference Share D p  = Dividend on preference share NP = Net proceeds from issue of preference share (Issue price – Flotation cost) RV = Redemption Value N = Period of preference share Example:  A company issues 20,000 irredeemable preference share at 8% whose face value is Rs.50 each at 4% discount. Find out the Cost of Preference Share Capital.
88 comments
Read more

What is the difference between Cheque book and Pass book?

 Cheque book is issued by bank in customers / account holder request. With the help of this book account holder can withdraw cash from his/her account. Bank does not charge any fee to issued cheque book to its customer. But afterward bank charges some amount for using bank facility like cheque book, Debit card etc.So, Automatic some definite amount deducted from customer bank account. Pass book is  also issued by bank to its customer. It helps to record all the bank related activity according to date that is withdrawal and deposit. It is recorded by bank but the book is kept by customer to know the current balance of  his /her account.  Point of difference Pass book Cheque book What is the meaning of pass book and cheque book? Passbook is a book in which all withdrawal and deposit against customer account is recorded.   Cheque book is a book of cheques which are used to withdrawal the money to bank account.
Post a Comment
Read more

How to calculate interest on Hire Purchase System?

Interest on hire purchase:  Interest is calculated on Cash value of goods not in instalment value which includes cash value of goods and interest amount. It is calculated on yearly, quarterly and yearly basis. Interest is not calculated on down payment which is paid at delivery of goods. Depreciation is also charged on the hire purchase goods at the end of financial year. The method applies for depreciation is based on the contract between the parties.   Example:  Company V purchased a machine of Rs.70, 000 and paid Rs.5, 000 as down payment. The interest charged @6% and 8% depreciation annually. The instalment value for each year is Rs. 10,000. Find out the interest amount for 5 years. Solution: Interest calculated on Rs. Interest Instalment Cash Value 65, 000 65, 000*0.06 = 3, 900 12, 500 8, 600 56, 400 56, 400*0.06 = 3, 384 12, 500 9, 116 47, 284 47, 284*0.06 = 2, 837 12, 500 9, 6
3 comments
Read more