Question

Consider the following scenario analysis: Rate of Return Scenario Probability Stocks Bonds Recession 0.20 –9 % 21 % Normal economy 0.70 22 9 Boom 0.10 25 5

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.)

Answer 1

a.Expected return=Respective return*Respective probability

=(0.2*-9)+(0.7*22)+(0.1*25)=16.1%

probability	Return	probability*(Return-Expected rate of return)^2
0.2	-9	0.2*(-9-16.1)^2=126.002
0.7	22	0.7*(22-16.1)^2=24.367
0.1	25	0.1*(25-16.1)^2=7.921
		Total=158.29%

Standard deviation=[Total  probability*(Return-Expected rate of return)^2/Total probability]^(1/2)

=12.6%(Approx).

b.Expected return=Respective return*Respective probability

=(0.2*21)+(0.7*9)+(0.1*5)=11%

probability	Return	probability*(Return-Expected rate of return)^2
0.2	21	0.2*(21-11)^2=20
0.7	9	0.7*(9-11)^2=2.8
0.1	5	0.1*(5-11)^2=3.6
		Total=26.4%

Standard deviation=[Total  probability*(Return-Expected rate of return)^2/Total probability]^(1/2)

=5.1%(Approx)