You have saved $10,000 for a down payment on the purchase of a new car, however,...

You have saved $10,000 for a down payment on the purchase of a new car, however, since you plan to buy the car one year from today, you need to decide how to invest the money for one year. You are limited to one of two choices:

1. A Bond Fund with an expected return of 3%/year

2. A Stock Fund with an expected return of 7%/year.

Which fund is best? Explain why!

Solutions

Expert Solution

The bond fund is best because our investment horizon is only one year. The expected return on the stock is higher at 7%/year than the bond fund's expected return of 3%/year. However, the bond fund is more likely to deliver 3%/year than the stock fund to deliver 7%/year.

The stocks are riskers to invest for short term. The returns from the stock can be negative as well in one year. In that case, we would not have sufficient money to pay for the car down payment.

Our objective here is to protect the capital with minimum risk, not to achieve a higher return.

So, bond fund is the best!

jeff jeffy answered 2 years ago

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