Currently 10 year U.S. government Treasury Bills yield 1.82%. 10 year German gov

Question

Currently 10 year U.S. government Treasury Bills yield 1.82%. 10 year German government securities yield .38%, 10 year French government securities yield .57%, and 10 year Greek government securities yield 9.23%.   

Assume you are working for a pension fund and your employer directs you to invest $10 million into only one of these government securities that your organization plans to hold to maturity.

1. Which one would you invest in and explain why?

2. Discuss your interpretation of all of the variables: Rd   R*   IP   rRF    DRP   LP   MRP    for each security in regards to this question. Do not just give the definitions, explain how they apply in this situation.

Explanation / Answer

The return earned by an investor by investing in a risk free security is known as risk free rate of return (rRF). There is no truly risk free security available for investment but the closet risk free securities are bonds issued by government of a nation or a body like that. In the absence of inflation nominal return on a default free bond will be equal to the risk free rate of return. Nominal rate of return (rd) is the sum of real risk free rate (r*), inflation premium (IP), default risk premium (DRP), liquidity premium (LP) and market risk premium (MRP).

The given all securities are issued by government so their return will be default free. The return offered by Greek securities is the highest so it is most suitable investment destination to earn highest return.

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