Sorry for not being able to post in legible format?
Can some one explain why should we invest in bonds because when interest rates rise- returns are reduced, so we should reduce allocation to bonds,
For Each Asset Class, Determine Whether the Allocation Should Be Increased, Reduced or Held Constant
“In response to a rapidly expanding economy, the central bank is expected to tighten the monetary policy to bring inflation under control.” Option 1: Stocks Option 2: Bonds
Given the central bank’s reputation to respond slowly to changes in economic conditions, a rapidly expanding economy can be the sole cause for an unanticipated surge in inflation.” Option 1: Stocks Option 2: Bonds
For #1, you could make the argument that Long-term bonds would be good because of reduced inflation expectations thus premium for future yield down. What question is this?
Think of this in terms of inflation. Bonds generally perform well during times of deflation. Suppose you hold a fixed coupon bond. You are receiving fixed coupon payments. When there is deflation in the economy, the value of those coupons in real sense is more and your actual earnings power gets increased. Opposite it true when inflation increases. So, in the cases provided,
Case 1. If central bank is about to tighten monetary policy, it is curbing the high inflation. If inflation expectations are about to reduce, as per above logic, we should increase our % of Bond allocations in our portfolio (As Jsnazz mentioned, inflation premium charged by investors will be lower, so they will be satisfied with a lower yield).
Case 2. If there are high unanticipated surge in inflation and central bank is slow to respond, we should increase our % of Equity allocations. Bonds will definitely not work well as inflation is high (real purchasing power with coupons comes down). Equities CAN do well here if the companies can pass on the unanticipated inflation costs to consumers.
this is a crappy question, finquiz sucks stop taking their mocks people. Use old CFAI ones. finquiz questions are poorly written and not well thought out.