ABSTRACT

The case briefs about the benefits and drawbacks of investing in stocks, government treasuries and bonds and mutual funds. The rising and falling of interest rates play a major role in the value or return from the investments. As the interest rate increases the bond prices falls which further increases the yield to maturity and vice versa. The economic conditions play a very crucial role in deciding whether bonds actually are good to park your funds or not. If the economic conditions are likely to improve bonds could turn out to be the worst investment for the investors as the investors will lose the profit which they would have gained if the funds were invested in stocks. Similarly, if the economic conditions are expected not to improve then bonds are haven as they will get the redemption value on maturity. Therefore, to decide whether the investment made is good or bad depends majorly on the market fluctuations due to economic conditions.

Ans 1: Constantly rising interest rates lead to decrease in the value of the bond, hence the investors who already own the bonds will get lower value of the bond thus causing substantial loss to them. A 30- year bond can lose 10% of its value for every 1% point rise in prevailing rates. Increase in the interest rates increase the borrowing cost which decreases the capital gain on maturity and the majority of federal debt matures in less than 5 years therefore the government will have to constantly sell new bonds to pay off old ones.

Ans 2: Because of the uncertainty of the profits on the stocks due to the government debt problems in US and Europe, rising oil prices and slowdown in china and the other emerging markets and the troubled housing market in U.S investors prefer to safeguard their money in bonds. This uncertainty has led to massive increase in the demand of the bonds which has led to increase in the price of the bonds and with the increase in the prices the yield has gone extraordinary low.

Ans 3: The Feds main tool is its strong influence over short-term interest rates. The fed tackled inflation by raising short term interest rates. Increase in the interest rates raised the borrowing cost which further reduced the spending. This led to decrease in the demand which restricted the price to rise which helped to control the inflation.

Ans 4: With the increase in the interest rates the borrowing cost will go up making it expensive to buy for the investors leading yield to rise further. It will be beneficial for the savers but will hit the value of bond investors in return. Due to increase in the interest rate the yield will go up on new bonds would ultimately bring down the values of the older bond holders. The owners of mutual funds cannot wait for maturity date to redeem at full value because sharp rise in the interest rates could cause deep losses for many bond fund investors. Bonds are the best investment when the market conditions are not good but if the market conditions improve it may prove to be the worst investments for the investors as they will lose the returns which they might gain if they would have invested in the stocks. Hence, bonds are the worst asset class for the investors if the economic conditions improve.