You have $5,000 to invest for the next year and are considering three alternatives: A money...

You have $5,000 to invest for the next year and are considering three alternatives: A money market fund with an average maturity of 30 days offering a current yield of 2.0% per year A 1-year savings deposit at a bank offering an interest rate of 4.0% A 20-year U.S. Treasury bond offering a yield to maturity of 4.0% per year A 20-year corporate bond offering a yield to maturity of 7. What is the risk profile of each of these assets? What role does your forecast of future interest rates play in your decisions?

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Expert Solution

Money Market fund:

This is a highly risky investment but the liquidity is very high. However, the returns are very average, hence not worth the risk it ensues.

Savings Bank Deposit:

There is no risk whatsoever. However the lock-in period of the fund is higher than that of the money market fund. The returns are just about enough to beat inflation rates.

US Treasury Bond:

This is another investment option with very low risk. However, the lock-in period of 20 years means that the capital is stuck for a long period of time. However, the time value of money will ensure that the compounded return will give a princely sum on maturity.

Considering all these factors, we can easily say that if the money is idle and will not be required for a long time( basically sums like retirement corpus), then the Treasury Bond is the best option. However, if the investor is okay to highly risky options, then the Money Market Fund could be the option.

jeff jeffy answered 3 months ago

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