Consider the following scenario analysis: Rate of Return Scenario Probability Stocks Bonds Recession 0.20 −4 % 16 % Normal economy 0.50 18 % 9 % Boom 0.30 29 % 6 % a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? Yes or No 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.) Expected Rate of Return Standard deviation Stock Bond c. Which investment would you prefer?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider the following scenario analysis:
| Scenario | Probability | Stocks | Bonds | ||
| Recession | 0.20 | −4 | % | 16 | % |
| Normal economy | 0.50 | 18 | % | 9 | % |
| Boom | 0.30 | 29 | % | 6 | % |
a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?
Yes or No
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.)
Expected Rate of Return Standard deviation
Stock
Bond
c. Which investment would you prefer?
Trending now
This is a popular solution!
Step by step
Solved in 7 steps with 4 images
