risks and rates of return?

Question

I have been looking into ways to invest some money and these are some questions that I came up with from the internet can anyone help me answer these so that I can make the correct decisions.
Suppose you owned a portfolio consisting of $250,000 worth of long-term U.S. government
bonds.
a. Would your portfolio be riskless?
b. Now suppose you hold a portfolio consisting of $250,000 worth 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? Could someone develop such
an asset? Explain.

Answer 1

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.

Answer 2

Let us break up this question and also ask a question.

For starters, let us look at long term bonds. Are they riskless? They are backed by the full faith and credit of the United States. There is no default risk because they could simply print the money to pay you. If they did that, however, inflation would destroy the value of the bonds so the purchasing power would be destroyed. So yes there is substantial risk, if inflation is considered a risk.

Bills provide a long run return approximately equal to the inflation rate. So, if you reinvested the money each period, you would retain constant purchasing power. Since you are living off the money, your purchasing power will decline due to inflation so it is a risky proposition, possibly riskier than the bonds since you are not being compensated for the long holding time.

Finally, if interest rates vary from period to period, you would have interperiod purchasing power risk.

As an example, if you bought treasuries in 1982, you would have gotten about a 15% rate of return, if memory serves me. Because of the renewal each three months, that would have been around 2% in just three weeks ago during the credit crisis. Your income would have gone from around $37,500 to $5,000. This is very risky even ignoring taxes. Even though you would average out with inflation, it would require substantive consumption shifts.

A completely riskless asset would be a sovereign asset issued by a government that would never be subject to revolution or conquest with an unimpeachable national character in its leadership. It would pay interest daily at a rate equal to the inflation rate, plus a premium for the time until maturity and any taxes on the interest. Further, it would reinvest the inflation premium daily on a tax free basis.

Hope you enjoyed your homework.

Finally, the question:

What is risk? If risk is not meeting a goal, then the soveriegn instrument above would have to be designed to meet your personal goals. If risk is variability then the above works. What is risk and what is it to you personally? Think about it.

Answer 3

The long term bonds would be almost riskless in terms of the U.S. refusing to pay at maturity. But they have considerable risk of the maturity value not being worth as much as assumed because of inflation reducing the purchasing power of the dollars repaid. The short term bills have also about zero risk of default, and the term of each bill is so short there will be little inflation risk. But holding a series of such bills over a time period equal to that of the bond would have the same total risk. One would also have fewer dollars at the end because of the lower interest rate paid by bills compared to bonds. There is no such thing as a riskless investment.

However, if you are not too old, investing in stocks can be almost riskless. If you purchase stocks that pay a good dividend yield, have a history of increasing dividends and earnings per share, and have earnings per share covering dividend payments by a good margin, and you reinvest dividends, and periodically buy more shares, you are as good as completely safe. Since 1926 until now there has never been a fifeen year period when stock investing, deflated for inflation, has not provided an average real yield of over 3.5 per cent.

Yes, there can be short term price drops like the 90 per cent of 1929 - 1932. But even this was all right by 1941. And this was good, not bad. The dividend reinvestments and additional stock purchases bought huge numbers of additional shares at rock bottom prices. Also at least half the politicians now know that stock market panics will only be turned into a depression if taxes are raised, and reducing taxes boosts the economy and actually increases government tax revenues.

Answer 4

a. US bonds and T-bills are about as close as one can come to being riskless, but are not literally riskless. The risk of the US government failing to honor them is incredibly small, but not zero. The risk of the return failing to match the inflation rate is small for T-bills (larger for longer-duration bonds) but not zero.

b. Since you want to maintain a constant standard of living, but the new rates every 30 days will not be constant, and the rate of inflation is not constant, then no, it is not riskless in that specific context.

c. Life is not riskless. There are no riskless assets in the literal sense, although there are several that are safe enough that people generally consider them equivalent to riskless.

Answer 5

Treasuries are considered riskless from default. But they still have price swings. The longer term the more risk you take from interest rate changes. 90 day bills or less would be the safest. There probably isnt any investment that is completely safe.

Answer 6

a. Your risk will depend on the ability of the US government to pay its debt. It can always raise tax (though the consequences for the administration might not be pretty), so you can be sure that you will get your money back (at least the nominal amount).

b. The same as a

c. US government debt is the closest thing to riskelss asset.

Note:
Please remember that when you choose 1 investment over the other, you're also taking opportunity risk. For instance, you might be getting, say, 5% from the bond market while, had you invested your money in, say, real esate, you might have got 10%.

Answer 7

a. nothing is riskless... there are many types of risk... for your example the most common risk would be interest rate risk... and opportunity cost risk and inflation risk.

b. no ... you'd be extremely exposed to inflation risk. as inflation increased your income would decrease relative to the initial standard of living.

c. no.. no never.... there will always be risks... even i you are sitting 100% in cash you will have inflation risk... if you are 100% gold you will have market risk ... etc etc

good luck with your homework.

Answer 8

Treasury bonds and bills are considered risk-less, however, if you think that the US government may default then they are not risk-less. Also, bills have less risk than bonds due to their short-term nature.

The US treasury instruments are the lowest risk instruments available, well except for government securities of other developed and stable countries.

Answer 9

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http://www.investingtutorial.info/

good luck !

wish you make fortune from investing !

Answer 10

the higher the rates, the higher the risk.