Question

You plan to invest $1,000 in a corporate bond fund or in common stock fund. The following table presents the annual return (per $1000) of each of these investments under various economic conditions and the probability that each of those economic conditions will occur .

Probability Economic Corporate| Common Condition Bond Fund Stock Fund

0.02 Extreme Recession . -200 -990

0.08 Recession -70 -300

0.15 Stagnation 30 -100

0.30 Slow Growth 70 100

0.35 Moderate growth 90 150

0.10 High growth 100 300

Compute the following a. expected return for the corporate bond fund and for the common stock fund. b. standard deviation for the corporate bond fund and for common stock fund. c. co-variance of the corporate bond fund and the common stock fund. d. would you invest in the corporate bond fund or the common stock fund? Explain e. If you chose to invest n the common stock fund in (d) what do you think about the possibility of losing $999 of the $1000 invested if there is extreme recession?

Answer 1

Please find below table useful to compute desired results: -

D F G -70 1-100 100 300 10 1 Probability Corporate Bond Fund Common Stock Fund 2 0.02 -200 -990 3 0.08 -300 4 0.15 5 0.3 100 6 0.35 90 150 7 0.1 8 =SUM(A2-A7) =SUMB2:B7) =SUM(C2:07) 9 a.. Expected return for the corporate bond fund 11 =SUMPRODUCT(B2:B7,A2:A7) 12 Expected return for the common stock fund 13 =SUMPRODUCT(C2:C7,A2:A7) 14 b.. 15 Standard Deviation for corporate bond fund 16 =SQRT(SUMPRODUCT(B2:B7,A2:A7,B2:B7)-A11*All) Standard Deviation for common stock fund 18 =SQRT(SUMPRODUCT(C2:C7,A2:A7,C2:07)-A13*A13) 19 c.. 20 co-variance of the corporate bond fund and the common stock fund 21 =COVAR(B2:B7,C2:07) 17

End results would be as follows: -

D E F G H I KL (990) А 1 Probability Corporate Bond Fund Common Stock Fund 0.02 (200) 0.08 (70) (300) 0.15 (100) 0.30 100 0.35 150 0.10 300 (840) 90 100 1.00) 20 Expected return for the corporate bond fund 57.40 22 Expected return for the common stock fund 13 53.70 15 Standard Deviation for corporate bond fund 16 57.77 Standard Deviation for common stock fund 212.82 19 C.. co-variance of the corporate bond fund and the common stock fund 21 44,883.33 22 d.. 23 one should invest in corporate bond fund because it gives higher expected return and has low standard deviation