10. Given her evaluation of current economic conditions, Ima Nutt believes there is a 20 percent probability of recession, a 50 percent chance of continued steady growth, and a 30 percent probability of inflationary growth. For each possibility, Ima has developed an interest rate forecast for long-term Treasury bond interest rates:

ECONOMIC INTEREST RATE FORECAST FORECAST

Recession 6 percent

Constant growth 9 percent

Inflation 14 percent

a. What is the expected interest rate under Ima’s forecast?

b. What is the variance and standard deviation of Ima’s interest rate forecast?

c. What is the coefficient of variation of Ima’s interest rate forecast?

d. If the current long-term Treasury bond interest rate is 8 percent, should Ima consider purchasing a Treasury bond? Why or why not

19. EXCEL Spreadsheets are useful for computing statistics: averages, standard deviation, variance, and correlation are included as built-in functions. Below is recent monthly stock return data for ExxonMobil (XOM) and Microsoft (MSFT). Using a spreadsheet and its functions, compute the average, variance, standard deviation, and correlation between the returns for these stocks. What does the correlation between the returns imply for a portfolio containing both stocks?

MONTH XOM RETURN MSFT RETURN

November 4.6% 10.4%

October 0.1% 13.6%

September 1.9% 10.3%

August 3.3% 13.8%

July 4.4% 9.3%

June 1.6% 5.5%

May 0.7% 2.1%

April 9.4% 23.9%

March 0.1% 7.3%

February 3.2% 3.4%