Assume that you recently graduated and landed a job as a financial planner with Cicero Services, an investment advisory company. The Client presently owns a bond portfolio with $1 million invested in zero coupon Treasury bonds that mature in 10 years. (The total par value at maturity is $1.79 million and yield to maturity is about 6%, but that information is not necessary for the mini case.) You have calculated the rate of return on 10-year zero coupon for each scenario.

Scenario Probability Return on a 10-year Zero

of Scenario Coupon During the next year

Worst Case 0.10 -14%

Poor Case 0.20 -4%

Most Likely 0.40 6%

Good Case 0.20 16%

Best Case 0.10 26%

1.00

Historical Stock Returns

Year Market Blandy Gourmange

1 30% 26% 47%

2 7 15 -54

3 18 -14 15

4 -22 -15 7

5 -14 2 -28

6 10 -18 40

7 26 42 17

8 -10 30 -23

9 -3 -32 -4

10 38 28 75

Average 8.0% ? 9.2%

Return

Standard 20.1% ? 38.6%

Deviation

Correlation

With Market 1.00 ? 0.678

Beta 1.00 ? 1.30

The Risk Free Rate is 4% and the market risk premium is 5%

1. -What are investments returns? What is the return on an investment that costs $1,000
2. -Graph the probability distribution for the binds returns based on the 5 scenarios. What might the graph of the probability distribution look like if there were an infinite number of scenarios if it were a continuous scenario.
3. -Use the scenario data to calculate the expected rate of return for the 10-year zero coupon Treasury bonds during the next year.
4. -What is stand-alone risk? Use the scenario data to calculate the standard deviation of the bond