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%
Use the data above and consider 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? Explain.
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The solution calculates the expected rate of return and standard deviation of a portfolio composed of bonds and stocks, given probability distribution of return on stocks and bonds.