Consider the following scenario analysis Rate of Return Bonds 20% Scenario Reces

Question

Consider the following scenario analysis Rate of Return Bonds 20% Scenario Recession Normal economy Boom Probability Stocks .20 50 30 -9% 21 31 a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? O Yes 0 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

Explanation / Answer

a) Yes ( 20% vs 8%) b) STOCKS Probability Return Probability*Return (Return - expected return)^2 Recession 0.2 -0.09 -0.018 0.0729 Normal economy 0.5 0.21 0.105 0.0009 Bom 0.3 0.31 0.093 0.0169 Sum 0.1800 Variance 0.0907 Expected Return = .180 or 18.0% Standard Deviation 0.301164 Standard Deviation 30.12% BONDS Probability Return Probability*Return (Return - expected return)^2 Recession 0.2 0.2 0.04 0.009216 Normal economy 0.5 0.08 0.04 0.000576 Bom 0.3 0.08 0.024 0.000576 Sum 0.104 Variance 0.010368 Expected Return = .104 or 10.4% Standard Deviation 0.101823 Standard Deviation 10.18% Note: sum is the sum of (probability * return) Variance = sum of (Return - expected return)^2 Standard Deviation = (Variance)^.5 Expected Rate of return Standard Deviation Stocks 18.0% 30.1% Bonds 10.4% 10.1%

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