Answer and Explanation:
a. Here it is reasonable to presume that the treasury bond generates high returns when there is a recession.
b. The calculation of the expected rate of return and the standard deviation for each investment is shown below:
For stocks
= (Expected return of the boom × weightage of boom) + (expected return of the normal economy × weightage of normal economy) + (expected return of the recession × weightage of recession)
= (29% × 0.30) + (18% × 0.50) + (-4% × 0.20)
= 8.7% + 9% - 0.80%
= 16.9%
For bonds
= (Expected return of the boom × weightage of boom) + (expected return of the normal economy × weightage of normal economy) + (expected return of the recession × weightage of recession)
= (6% × 0.30) + (9% × 0.50) + (16% × 0.20)
= 1.8% + 4.5% + 3.2%
= 9.5%
Now the standard deviation calculation is to be shown in the excel spreadsheet
For the stock it is 11.48%
And, for the bond it is 3.5%
c. The investment that should be prefer could be computed by determine the coefficient of variation which is shown below:
Formula i.e. used is
= Standard deviation ÷ expected return
For stock, it is
= 16.9% ÷ 11.48%
= 1.47
And, for bonds it is
= 9.5% ÷ 3.5%
= 2.71
Since for the bonds the coefficient of variation is greater so the same is to be considered
Therefore the bond should be prefer
