1) SCENARIO ANALYSIS: Consider the following scenario-analysis
RATE OF RETURN
Scenerio Probability Stocks 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 recessions than in booms?
b. How do I calculate the
expected rate of return and standard deviation for each investment?
c. And which investments would you prefer?
2) PORTFOLIO ANALYSIS: Using the data in the above problem 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. Also, the expected rate of return and standard deviation for investment in a portfolio of bonds and stocks is calculated. This solution is provided in an attached Excel file.