You are discussing your 40l(k) with Dan Ervin when he mentions that Sarah Brown,

Question

You are discussing your 40l(k) with Dan Ervin when he mentions that Sarah Brown, a representative from Bledsoe Financial Services. is visiting East Coast Yachts today. You decide that you should meet with Sarah, so Dan sets up an appointment for you later in the day. When you sit down with Sarah. she discusses the various investment options available in the company's 401 (k) account. You mention to Sarah that you researched East Coast Yachts before you accepted your new job. You are confident in management's ability to lead the company. Analysis of the company has led to your belief that the company is growing and will achieve a greater market share in the future. You also feel you should support your employer. Given these considerations, along with the fact that you are a conservative investor, you are leaning toward investing 100 percent of your 401(k) account in East Coast Yachts. Assume the risk-free rate is 3.2 percent. The correlation between the Bledsoe bond fund and large-cap stock fund is .15. Note that the spreadsheet graphing and "solver'' functions may assist you in answering the following questions.

2. Sarah"s response to investing your 40l(k) account entirely in East Coast Yachts stock has convinced you that this may not be the best alternative. Because you are a conservative investor. you tell Sarah that a 100 percent investment in the bond fund may be the best alternative. Is it?

Explanation / Answer

Bond fund is not 100% risk free assets for diversification as it has four risk market interest rate risk,credit risk, inflation risk and prepayment risk.Its better to have a diversified portfolio,invest some in equity and some in bond funds  that makes the correlation between them as small as possible so that can minimize the systematic risk.

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