Consider the following scenario analysis:
Rate of Return
Scenario 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 a recession than in booms? Why?
b) Calculate the expected rate of return and standard deviation for each investment.
c) Which investment would you prefer?
a. Interest rates rise during booms and fall during recessions: that is, interest rates are procyclical. ...
The expected rate of return and standard deviation for the investment in bonds and stocks are calculated, given the probability distribution of return. Parts b. and c. are calculated in an Excel file which is attached.