1) SCENARIO ANALYSIS: Consider the following scenario analysis;
Scenario Probability Stock Bonds
Recession .20 -5% +14%
Normal economy .60 +15 +8%
Boom .20 +25 +4%
a) Is it reasonable to assume that Treasury bonds will provide higher returns in recession than in booms? Why?
b) Calculate the expected rate of return and standard deviation for each investment.
c) Which investment would you prefer?
2) PORTFOLIO ANAYSIS: using the data in the problem above and considering a portfolio with weights of .60 in stocks and .40 in bonds.
a.What is the rate of return on the portfolio in each scenario?
b.What is the expected rate of return and standard deviation of the portfolio?
c. Would you prefer to invest in the portfolio, in stocks only, or in bonds only,
The expected rate of return and standard deviation for investment in bonds and stocks is calculated, given the probability distribution of return.