You have assigned probabilities. You have also estimated expected returns for ea

Question

You have assigned probabilities. You have also estimated expected returns for each of the two funds for each scenario. Your spreadsheet looks like the following. Fill in columns D and F and calculate the expected return for each fund, given the probabilities for the four possible economic conditions and their associated rates of return. Given the expected value for each fund for next year, fill out the following spreadsheet to calculate the standard deviation of each fund. Note that you need to fill in columns D, E, and F for the stock fund, and columns H, I, and J for the bond fund. The first two columns in each set are labeled; you need to determine what goes in columns F and J, respectively, which will lead to the variance, and then the standard deviation. Now calculate the covariance between the two funds, and the correlation coefficient, using the following format. Using the formulas for the expected return and risk of a portfolio, calculate these values for each of the following portfolio weights. Which of the portfolio in (d) is the minimum variance portfolio? Based on your analysis, should investors hold a portfolio of 100 percent bonds? Answer to Question at the Beginning of the Chapter The price of gold can be very volatile, going down as well as up. Gold bullion has no current return (no income component) and has a carrying cost (interest cost if borrowed money is used to buy it, storage costs, and oppurtunity costs- an income-producing asset could have been bought instead).

Explanation / Answer

Answer : (A) Calculation of Expected return:

Answer: (b) (C) Stock fund :

variance = 118.99

Standard deviation = square root of variance = 10.90825

Bond fund:

Variance = 56.76

Standard deviation = square root of variance =7.53392

Answer: (d) calculation of covariance and correlation of coefficient:

covariance = 0.4125

correlation = covariance/ standard deviation of stock fund * standard deviation of bond fund

= .4125/10.90825*7.53392

=0.0050

Answer (e)

Next year probabilities Probability Stock fund rate of return D Bond fund rate of return F Recession 0.15 -13 -1.95 15 2.25 Weak econ 0.05 5 0.25 3 0.15 Average Econ 0.6 10 6 7 4.2 Strong Econ 0.2 24 4.8 -9 -1.8 Exp value 9.1 Exp value 4.8

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