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 0.20 –5 % 19 % Normal economy 0.70 20 10 Boom 0.10 32 9 a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? No Yes 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.)

Table for B

                Expected Rate of Return                     Standard Deviation

Stocks (%)

Bonds (%)

Explanation / Answer

(a) Yes, There is inverse relationship between interest and bond prices,. In boom interest goes to high and recession to low and in case of Bons it gos high in case of recession and in boom it price goes lowest Prob. Stocks Variance Bonds Variance Recession 0.2 -5%               89.89 19%           10.66 Normal 0.7 20%               10.11 10%             2.02 Boom 0.1 32%               24.96 9%             0.73 Expected Return 16.20%             124.96 11.70%           13.41 Sd 11.18% 3.66% (b) Expected Return Stock=.2*-5%+.7*20%+.1*32% 16.2% Bonds=.2*19%+.7*10%+.1*9% 11.7% Sd of Stock=(.2*(-5-16.20)^2+.7*(20-16.2)^2+.1*(32-16.2)^2)^.5 Sd of bond=(.2*(19-11.7)^2+.7*(10-11.7)^2+.1*(9-11.7)^2)^.5

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