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Consider the following scenario analysis:

Rate of Return

Scenario

Probability

Stocks

Bonds

Recession

.20

−8

%

16

%

Normal economy

.50

19

9

Boom

.30

25

6

a.

Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms?

Yes

No

b.

Calculate the expected rate of return and standard deviation for each investment. (Do not round intermediate calculations. Enter your answers as a percent rounded to 1 decimal place.)

Expected Rateof Return

StandardDeviation

Stocks

%

%

Bonds

%

%

Top hedge fund manager Diana Sauros believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $43. The stock will pay a dividend at year-end of $3.00. Assume that risk-free Treasury securities currently offer an interest rate of 1.8%.

Average rates of return on Treasury bills, government bonds, and common stocks, 1900–2013 (figures in percent per year) are as follows.

Portfolio

Average AnnualRate of Return

Average Premium (Extra returnversus Treasury bills)

Treasury bills

3.9

Treasury bonds

5.2

1.3

Common stocks

11.5

7.6

What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)

Discount rate

%

What price should she be willing to pay for the stock today? (Do not round intermediate calculations.Round your answer to 2 decimal places.)

Stock price

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