Question

. Jo Fixed would like to invest in the following three bonds:

A. Corporate AAA. 5% coupon, 20 yrs. to maturity, 4% YTM

B. High Yield BBB. 8% coupon, 10 yrs. to maturity, 10% YTM

C. US Treasury, 3% coupon, 3 yrs. to maturity, 2% YTM

Required: Recommend weights to Jo for each one of securities above assuming

i. Contraction

ii. Recession

iii. Recovery

weights > 0

Answer 1

I. In a scenario of contraction of an economy, I would be more concerned about investment into treasury bonds and high rated corporate bonds which can protect me against the contracting economies and I would be lesser concentrated in low rated corporate bonds as probability of default would be high.

My portfolio allocation would be 30% to the AAA corporate bonds and 50% to the the treasury bonds along with 20% to BBB corporate bond.

ii. In a scenario of recession, I would be exposed highly into United state treasury bond because these are risk free bonds and under any circumstances these will not default.I would allocate moderate amount to high rated corporate bonds and extremely minimum amount to low rated corporate bonds.

My portfolio allocation would be 60% to United state treasury bonds and 30% to AAA rated corporate bonds and 10% to BBB rated corporate bonds.

iii.under the recovery stage of an economy I would like to go aggressive and I would bet upon the risky bonds as the chances of revival of such bonds are very high in recovering economy so I would allocate the most to low rate corporate bonds and moderate to both high rated corporate bonds and United State treasuries.

My portfolio allocation would be 50% to BBB rsted corporate bonds and 30% to AAA rated corporate bonds and 20% to United state treasury bills.