The problem is in on an Excel Template at
http://www.angelfire.com/biz7/glorihayl/Chapter_04.xls
It's problem# 9-18. Please include formulas in Excel as well. Thank you. 

a. What is the rate of return on the portfolio in each scenario? 

b. What is the expected return and standard deviation of the portfolio? 

c. Would you prefer to invest in the portfolio of stocks only or in bonds only?

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Clarification of Question by nockmdead-ga on 05 Dec 2004 15:35 PST

The web link is wrong.  It should be: 
http://www.angelfire.com/biz7/glorihayl/Chapter_09.xls

Thanks.

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Clarification of Question by nockmdead-ga on 05 Dec 2004 15:49 PST

Deadline is December 11. Thanks.

Hi nockmdead!
Here are the answers to your questions.

a. The formula to calculate the rate of return of the portfolio in
each scenario is:

(Prop. of stocks)*(Ret. of stocks) + (Prop. of bonds)*(Ret. of Bonds)

The problem tells us that 60% (0.6) of the portfolio is invested in
stocks and 40% (0.4) is in bonds. Therefore, since in recession the
return of stocks is -5% (-0.05) and the return of bonds is 14% (0.14),
then the return of the portfolio in recession is:

0.6*(-0.05) + 0.4*0.14 = 0.026

So the return of the portfolio in recession is 2.6%. You can use the
same formula for the "normal" and "boom" cases. You can find the
results in the completed Excel sheet at:

http://www.angelfire.com/alt/elmarto/googleanswers/Chapter_09.xls

b. The expected return of the portfolio is easy to compute. It is just:

(Prob. of recession)*(Return in recession)
+ (Prob. of normal)*(Return in normal)
+ (Prob. of boom)*(Return in boom)

You can also find the exact answer in the Excel sheet. The formula for
variance is already included in the sheet you provided.

c. Since none of the options "dominates" the other two, the answer to
this question is a matter of personal preference. We would say that
one option dominates another one if it has the same expected return
with less variance, or if it has a higher expected return with the
same variance. In this case however, although the portfolio of stocks
has a higher expected return than bonds, it also carries a higher
variance, so there is no clear-cut answer to this question.
Personally, since I am very risk averse, I would choose to invest in
bonds only. But another person with less disliking for risk might very
well choose to invest in a portfolio of stocks only. In any case, the
decision should be based on your risk tolerance, that is, if you feel
that the expected reward (the return) is enough to offset the risk
you'll have to face.


I hope this helps! If you have any questions regarding my answer,
please don't hesitate to request a clarification. Otherwise I await
your rating and final comments.

Best wishes!
elmarto

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Request for Answer Clarification by nockmdead-ga on 06 Dec 2004 08:09 PST

Hi elmarto!  I just realized that Angelfire no longer allows remote
hosting, so when I click on either my link or the link you gave, I
can't access either page.  Help?

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Request for Answer Clarification by nockmdead-ga on 06 Dec 2004 08:21 PST

I answered my own question about the angelfire.  I typed in the link
with a "?" at the end.  That seems to get around the blocking message
from Angelfire.

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Clarification of Answer by elmarto-ga on 06 Dec 2004 09:46 PST

I'm glad you could access the file. Thanks for the nice comments!

I like that you explained the answer in detail.  Thanks.  A+!