Question

Consider the following scenario analysis: Scenario Recession Normal economy Boom Rate of Return Probability Stocks Bonds 0.20 -5% 14% 0.60 158 0.20 1 25 4 a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? • Yes No b. Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.) Expected Rate of Return Standard Deviation Stocks Bonds %

Answer 1

Expected Rate of Return - Rate of Return under Scenario x that scenario. Probability of - Expected Rate of Return of Stock = 0.20 - 5% + 0.60x15% 0-20 X25% = -1% + 9% + 5% = 13%

IDATE Expected Rate of Return of Bonds = 6.20x14% + 0.60x8% +0. 20x4% = 2 .8% + 4.8 %+ 0.8 = 8.40% Standard deviation =&E Probability of Scenariox Rate of Return of that v Scenario (-) Expected Rate of Return Standard Deviation of Stock 10.20(-5-13)2+0.60 (15-13)+0.20 (25-13) 164.80 +2.40+28. 80 = √96 = 9.80 Standard Deviation of Bonds. = 0.20 (14-8.40 + 0.6068-8.40) +0.2014 -8.40)* 6. 272+ 0.096+ 3.872 =v 10.24 - 3.20

Expected Rate of Return Standard Deviation Stocks Bonds 13% 8.40% 9.8 3.2