As a portfolio manager for an insurance company you are about to invest funds in one of three possible investments: (1) 10-year coupon bonds
issued by the U.S. Treasury (2) 20-year zero-coupon bonds issued by the Treasury or (3) one-year Treasury securities. Each possible investment is perceived
to have no risk of default. You plan to maintain this investment for a one-year period. The return of each investment over a one-year horizon will be about the
same if interest rates do not change over the next year. However you anticipate that the U.S. inflation rate will decline substantially over the next year
while most of the other portfolio managers in the United States expect inflation to increase slightly.
a. If your expectations are correct how will the return of each investment can be affected over the
b. If your expectations are correct which of the three investments should have the highest return over
the one-year horizon? Why?
c. Offer one reason why you might not select the investment that would have the highest expected return
over the one-year investment horizon.