Suppose you owned a portfolio consisting of $250,000 of US government bonds with
ID: 2662880 • Letter: S
Question
Suppose you owned a portfolio consisting of $250,000 of US government bonds with a maturity of 30 years.a. Would your portfolio be riskless?
b. Now suppose you hold a portfolio consisting of $250,000 of 30-day Treasury bills. Every 30 days your bills mature, and you reinvest the principal ($250,000) in a new batch of bills. Assume that you live on the investment income from your portfolio and that you want to maintain a constant standard of living. Is your portfolio truly riskless?
c. Can you think of any asset that would be completely riskless? What security comes closest to being riskless? Explain
Explanation / Answer
A. there is no such thing as a riskless investment. There is low risk, moderate risk, very low risk, etc... but not no risk.
When investing in US securites, it is true that you will get your original principal back. It is backed by "full faith in the US Gov't". So as long as someone believes that the US will pay its bills, its good. With bonds though, you run into interest rate risk, not default risk. What that means is that you must take the interest rate you are given. Could you do better? Sure. Would it be as safe? Maybe, but not guaranteed, by your faith.
Plus you also have investment risk, which deals with having your $ tied up long term to earn interest, that you could use to do other things like stimulate the economy.
B. As it was said, you have inflation risk. And interest risk. Will you ALWAYS get that same rate every 30 days? Will it ever decrease? Increase? If you can guarantee your rate will never decrease, its fine, but you cant. Even a bank CD is not guaranteed to renew at the same rate or higher.
C. No. Although it is not market risk, it is some type of risk attached to any investment. Otherwise its not an investment.
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