Question

In: Finance

Consider the following scenario analysis: Rate of Return Scenario Probability Stocks Bonds Recession 0.20 −9 %...

Consider the following scenario analysis:

Rate of Return
Scenario Probability Stocks Bonds
Recession 0.20 −9 % 20 %
Normal economy 0.50 21 % 8 %
Boom 0.30 31 % 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.)

c. Which investment would you prefer?

Solutions

Expert Solution

Ans:-  

Ans:- (a) Treasury Bonds are issued by the U.S government which has a fixed interest rate until maturity. It is a risk-free debt security, therefore T-Bonds does not have any effect of recessions or booms. Therefore it is not reasonable to assume that Treasury Bonds will have higher returns in recessions than in Booms. option (a) is the right answer.

But Bonds, in this case, will Provide higher returns in Recessions (0.20*20% = 4%) than in Booms (0.30*8%=2.4%).

(b) For expected return and Standard deviation (SD), pls find the answers in images above.

(c) I will invest in Bonds because I am a risk-averse investor. From the above analysis clearly, Bonds are less risky as compared to stocks because they have less SD than Stocks.

Note:- If this answer helps you pls give thumbs up.


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