Suppose you owned a portfolio consisting of $250,000 of U.S. government bonds wi

Question

Suppose you owned a portfolio consisting of $250,000 of U.S. government bonds with a maturity date of 30 years. Would your portfolio be riskless? What if your portfolio consisted of $250,000 of 30-day Treasury bills? Every 30 days your bills mature, and you reinvest the principle ($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? Can you think of any asset that would be completely riskless? What security comes closest to being riskless? Explain.

Explanation / Answer

1. Yes. US government long-term bonds are risk-free as they ensure guaranteed servicing, ie. timely interest payments and full repayment .The most reliable credit rating agency,Standard and Poor has given thses bonds AAA rating.Risk is only when there happens something highly unusually abnormal with US economy-even then the US Government is not probable to default.Risk ,if at all may be loss due to inflation.

2.As far as the regularity of income,Short-term T-Bills are comparatively risk-less- as they are backed by the US Government.They carry current interest rates and serve as a standard for many to calculate the cost of their funds.

3. No asset is completely risk-less . Even cash runs the risk of loss or theft.Money in the bank also carries risk of failure of banks.

4.Short-term Treasury Bills come closest to being riskless because:

they are backed by the US government which is known for its creditworthiness

their maturities are short ,so there is no interest rate risk- change in interest rates causes change in the value of the security.

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