Question

Consider the following scenario analysis:

		Rate of Return
Scenario	Probability	Stocks		Bonds
Recession	0.20	−4	%	19	%
Normal economy	0.40	20	%	9	%
Boom	0.40	26	%	8	%

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.)

Answer 1

a

yes, in recession bond return = 20% higher than -4% from stocks

b

Stock
Scenario	Probability	Return%	=rate of return% * probability	Actual return -expected return(A)%	(A)^2* probability
Recession	0.2	-4	-0.8	-21.6	0.0093312
Normal	0.4	20	8	2.4	0.0002304
Boom	0.4	26	10.4	8.4	0.0028224
	Expected return %=	sum of weighted return =	17.6	Sum=Variance Stock=	0.01238
			Standard deviation of Stock%	=(Variance)^(1/2)	11.13
Bond
Scenario	Probability	Return%	=rate of return% * probability	Actual return -expected return(A)%	(B)^2* probability
Recession	0.2	19	3.8	8.4	0.0014112
Normal	0.4	9	3.6	-1.6	0.0001024
Boom	0.4	8	3.2	-2.6	0.0002704
	Expected return %=	sum of weighted return =	10.6	Sum=Variance Bond=	0.00178
			Standard deviation of Bond%	=(Variance)^(1/2)	4.22