Question

Mr. Smith, your client, has maintained about 80% of his portfolio in fixed income securities. Interest rates are expected to decline over the next 12 month period. Mr. Smith calls you because he is concerned about this prediction and his portfolio. Which of the following recommendations would be appropriate for you to give to Mr. Smith?

[A] Move 50% of his portfolio into equity securities
[B] Leave his portfolio the way it is now
[C] Move 60% of his portfolio into Money Market funds
[D] Move 25% of his portfolio into Limited Partnerships

Answer 1

(B) Leave his portfolio the way it is now

Step-by-step explanation:

Bond value and market interest rates are inversely related. When the market interest rates are expected to decline and an investor already holds a bond with fixed rate of interest, the value of such bonds shall rise.

Market interest rates refer to the rate of interest other firms are offering on similarly priced bonds. Thus market interest rate also implies investor expectations i.e YTM (yield to maturity) which is used as a discounting factor to ascertain the price of a bond.

Lesser the discounting rate (yield to maturity), higher shall be the value of a bond.

Thus, it is recommended for Mr Smith to (B) leave his portfolio the way it is now.