Question

If you were certain that the economy will recover strongly during the second half of 2020,...

If you were certain that the economy will recover strongly during the second half of 2020, would you rather own a portfolio of stocks or long-duration bonds? Why? If, today, you own a substantial amount of 30-year Treasury bonds at a YTM of 1.50%, and by year-end, the market yield on those bonds is 2.50%, would you then be better or worse off? Why?

Homework Answers

Answer #1

Owning a portfolio of stocks will be more profitable as compared to long duration bonds.

If indicators are of strong recovery, then the stock will perform far better than the long term bonds because the current valuations of the stocks are very low and attractive. The stock prices will increases and capital gain will me immense. On the other hand, owning a long term bond will provide us limited gains and coupon payments at that particular point of time.

If the YTM of the bond rises from 1.5% to 2.5%, the price of the bond will fall. It is known that if YTM rises, price of the bond decreases as discounting factor increases. However, if the YTM falls, price increases. Therefore, in this case an increase in YTM will make inventory worse.

If you have any doubt, ask me in the comment section.

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