Exercise #7

Exercise #7 - Answer a Recession − 5 × 0.6(14 × 0.4 =...

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1 Finance 351: Financial Management Instructor: Shuming Liu In-Class Exercise 7 Chapter 11 Question 18 Using the data in the following table and consider a portfolio with weights of .60 in stocks and .40 in bonds. Rate of Return Scenario Probability Stocks Bonds Recession .20 -5% +14% Normal Economy .60 +15 +8 Boom .20 +25 +4 a. What is the rate of return on the portfolio in each scenario? b. What are the expected rate of return and standard deviation of the portfolio?
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Unformatted text preview: Answer: a. Recession ( − 5% × 0.6) + (14% × 0.4) = 2.6% Normal economy (15% × 0.6) + (8% × 0.4) = 12.2% Boom (25% × 0.6) + (4% × 0.4) = 16.6% b. Expected return = (0.2 × 2.6%) + (0.6 × 12.2%) + (0.2 × 16.6%) = 11.16% Variance = [0.2 × (0.026 – 0.1116) 2 ] + [0.6 × (0.122 – 0.1116) 2 ] + [0.2 × (0.166 – 0.1116) 2 ] = 0.002122 Standard deviation = 002122 . = 0.0461 = 4.61%...
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