Question

As a portfolio manager for an insurance company, you are about to invest funds in one of three possible investments: (1) 10-year coupon bonds issued by the U.S. Treasury, (2) 20-year zero-coupon bonds issued by the Treasury, or (3) one-year Treasury securities. Each possible investment is perceived to have no risk of default. You plan to maintain this investment for a one-year period. The return of each investment over a one-year horizon would be about the same if interest rates do not change over the next year. However, you anticipate that the U.S. inflation rate will decline substantially over the next year, while most of the other portfolio managers in the United States expect inflation to increase slightly.

a. If your expectations are correct, how will the return of each investment be affected over a one-year horizon?

b. If your expectations are correct, which of the three investments should have the highest return over the one-year horizon? Why?

c. Offer one reason why you might not select the investment that would have the highest expected return over the one-year investment horizon.

Answer #1

You have $1,000 to invest over an investment horizon of three
years. The bond market offers various options. You can buy (i) a
sequence of three one-year bonds; or (ii) a three-year bond; The
current yield curve tells you that the one-year, two-year, and
three-year yields to maturity are 2.5 percent, 4 percent, and 2.7
percent, respectively. You expect that one-year interest rates will
be 5 percent next year and 5 percent the year after that. Assuming
annual compounding, compute...

You invest $100 in a complete portfolio. The complete portfolio
is composed of a risky asset with an expected rate of return of 12%
and a standard deviation of 10% and a treasury bill with a rate of
return of 5%.
What would be the weight of your investment allocated to the
risk-free asset if you want to have a portfolio standard deviation
of 9%? (2 points)
How could you use these two investments to generate an expected
return of...

You invest $10,000 in portfolio XYZ. The portfolio XYZ is
composed of a risky asset with an expected rate of return of 15%
and a standard deviation of 20% over the one year time period. The
risk free asset has a rate of return of 5% over the same time
period. How much money should be invested in the risky asset so
that the standard deviation of returns on XYZ portfolio is 10% over
the one year time horizon

You work as the treasurer of a large manufacturing corporation
where earnings are down substantially as a result of COVID-19. In
an environment where interest rates are going to decline over the
next three to six months, you want to invest in fixed-income
securities to make as much money as possible for the firm. The
board recommends investing in one of the following securities:
Three-month Treasury Bill
Twenty-year Corporate Bonds
Twenty-year zero-coupon Treasury Bonds
Describe a suitable strategy based on...

You work as the treasurer of a large manufacturing corporation
where earnings are down substantially as a result of COVID-19. In
an environment where interest rates are going to decline over the
next three to six months, you want to invest in fixed-income
securities to make as much money as possible for the firm. The
board recommends investing in one of the following securities: •
Three-month Treasury Bill • Twenty-year Corporate Bonds •
Twenty-year zero-coupon Treasury Bonds Describe a suitable...

3. You
bought one of BB Co.’s 10% coupon bonds one year ago for $1100.
These bonds make annual payments, have a face value of $1000 each,
and mature seven years from now. Suppose you decide to sell your
bonds today, when the required return on the bonds is 8%. If the
inflation rate was 3% over the past year, what would be your total
real return on investment according to the Exact Fisher
Formula?

Inflation is expected to be 3 percent over the next year. You
desire an annual real rate of return of 2.5 percent on your
investments. What market rate of interest would have to be offered
on a one-year Treasury security for you to consider making an
investment?
1.5 percent
5.5 percent
4.5 percent
0.5 percent
None of the above

The first two questions below rely on the following assumptions:
Exactly one year ago, you purchased $10,000 of U.S Treasury Bonds.
These bonds have a maturity date 30 years from the time of
purchase. The annual coupon rate on these bonds at the time of
purchase was 4%. The U.S Treasury today has issued 30 year bonds
with an initial coupon rate of 5%. There are no transactions fees
to buy or sell these bonds. 1. Calculate the current price...

You bought one of Mastadon Manufacturing Co.’s 8.6 percent
coupon bonds one year ago for $1,046. These bonds make annual
payments, mature fifteen years from now, and have a par value of
$1,000. Suppose you decide to sell your bonds today, when the
required return on the bonds is 8 percent. If the inflation rate
was 3.0 percent over the past year, what would be your total real
return on the investment?

Assume you had the following investment in Exxon Bonds. You
bought one of Exxon's 11 percent coupon bonds one year ago for
$760. These bonds make annual payments and mature 14 years from
now. Suppose you decide to sell your bonds today, when the required
return on the bonds is 14 percent. If the inflation rate was 3.2
percent over the past year, what was your total real return on
investment?

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