8-1 Suppose you owned a portfolio consisting of $250,000 of long-term U.S. gover

Question

8-1 Suppose you owned a portfolio consisting of $250,000 of long-term U.S. government bonds. a. Would your portfolio be riskless? Explain. b. Now suppose the portfolio consists of $250,000 of 30-day Treasury bills. Every 30 days your bills mature, and you will reinvest the principal ($250,000) in a new batch of bills. You plan to live on the investment income from your portfolio, and you want to maintain a constant standard of living. Is the T-bill portfolio truly riskless? Explain. c. What is the least risky security you can think of? Explain.

Explanation / Answer

a) No because there would be interest rate risk. if interest rates increased and you needed to sell bonds you would be subject to loss of principal.
b) No because if the rate of inflation were higher than your return on the bills you investment would continually lose purchasing power. Also, if you are spending the interest and not reinvesting it, your principal becomes worth less in purchasing power if there is any inflation at all.
c) There is probably no completely riskless asset. What comes the closest is TIPS, U.S. government securities that adjust their returns upwards if inflation increases.

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