Question

Phillip is a mortgage broker, who is paid by commission. When interest rates decline, he does a lot of business and earns a lot of money, as more people buy houses or refinance their mortgages. But when interest rates rise, business falls substantially. To diversify, Phillip should choose investments that:______.

a. provide a higher return than the market average.
b. provide a lower return than the market average.
c. pay higher returns when interest rates rise and lower returns when interest rates fall.
d. pay lower returns when interest rates rise and higher returns when interest rates fall.

Answer 1

Answer: c. pay higher returns when interest rates rise and lower returns when interest rates fall.

Step-by-step explanation:

Phillip should invest in financial vehicles that earn more returns when interest rates are high thus offsetting the loss in revenue that he will suffer as a result of the increased interest rates.

Conversely those investments would probably make less returns in a low interest rate environment which will be offset by the higher earnings Phillip receives from the same low interest environment.

This is why diversification into inversely correlated assets is important because stability is maintained in the face of losses to one segment of investments