Question
Hull Consultants, a famous think tank in the Midwest, has provided probability estimates for the four potential economic states for the coming year in the
Hull Consultants, a famous think tank in the Midwest, has provided probability estimates for the four potential economic states for the coming year in the following table:
Investment Forecasted Returns for Boom Economy Forecasted Returns for Stable Growth Economy Forecasted Returns for Stagnant Economy Forecasted Returns for Recession Economy Stock 23% 10% 3% -14% Corporate bond 9% 7% 5% 4% Government bond 8% 6% 4% 3%
The probability of a boom economy is 10%, the probability of a stable growth economy is 16%, the probability of a stagnant economy is 54%,and the probability of a recession is 20%. Calculate the variance and the standard deviation of the three investments: stock, corporate bond, and government bond. If the estimates for both the probabilities of the economy and the returns in each state of the economy are correct, which investment would you choose, considering both risk and return?
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