Consider the following scenario analysis: Rate of Return Scenario Probability St

Question

Consider the following scenario analysis: Rate of Return Scenario

Probability Stocks Bonds

Recession .20 6 % +17 %

Normal economy .50 +20 +8

Boom .30 +29 +6

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. Round your answers to 1 decimal place.) Expected Rate of Return Standard Deviation Stocks % % Bonds % % c. Which investment would you prefer? Stocks Bonds

Explanation / Answer

b)Stocks:

Expected return of stock 1=(0.2*-6%)+(.5*20%)+(0.3*29%)=17.5%

var=0.2*(17.5%-(6%))^2+0.5*(17.5%-20%)^2+0.3*(17.5%-29%)^2=0.0153
std=var^.5=0.1238

bonds:

Expected return of stock 1=(0.2*17%)+(.5*8%)+(0.3*6%)=9.2%

var=0.2*(9.2%-17%))^2+0.5*(9.2%-8%)^2+0.3*(9.2%-6%)^2=0.0016
std=var^.5=0.0399

I would prefer bonds as they have less riskier than stocks as per std deviation

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