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She thinks the bond is risky and would require a default risk premium of about 3%. She sees that treasury bonds of equal duration (30 years) are selling for about 5% in the current economy. Question: Based on her understanding of the risks involved, is the investment appropriate for her?

Uncle Sal, the family accountant is home from his failed attempt at striking it rich in Vegas and wants to make up for it by selling a few securities on the side. He has an offer that he is pitching to an older lady he calls "Granny." The offer is for a 30 year bond issued by an insurance company and paying 7% annual interest. Sal will get a commission of 0.25% from the issuer of the bond. Granny has the $100,000.00 in a money market account earning 0.28% interest per year. Granny expects the inflation rate to average around 2.5% each year. She thinks the bond is risky and would require a default risk premium of about 3%. She sees that treasury bonds of equal duration (30 years) are selling for about 5% in the current economy. Question: Based on her understanding of the risks involved, is the investment appropriate for her?

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The offered investment has a return rate of 7%*(1-0.25%) = 6.98%
However, Granny's expected return rate = ...

Solution Summary

Simple computation and a few words to explain it.

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