Answer to Question #264803 in Microeconomics for queen

Question

Assume the expected return rate (answer from Part 1) is fixed and will not change for the next week. You wake up tomorrow and find out that open market operations by the the Federal Reserve chairperson push the (fictional) weekly Treasury bill fixed rate of return to 17.50%. Considering your investment options, how do you react to this news?

Choose one:

A. Continue investing in the asset portfolio because the Treasury bill return rate is lower.

B. Shift investment to Treasury bills because the asset portfolio return rate is higher.

C. Continue investing in the asset portfolio because the Treasury bill return rate is higher.

D. Shift investment to Treasury bills because the asset portfolio return rate is lower.

Answer 1

Solution:

The correct answer is D. Shift investment to Treasury bills because the asset portfolio return rate is lower.

The higher the rate for Treasury bills, the higher the return an investor will receive from investing in them. Since your expected return is fixed, it will be advisable to shift your investment to Treasury bills since they will be more lucrative than your asset portfolio return, which will be lower.