Reference no: EM132944538

Problem - You are a Financial Advisor and are putting together a Bond Portfolio for two different individuals:

A. Sharon is a thirty-two-year-old solicitor for large firm on a very good income. Apart from a reasonable mortgage on her flat in Saint Johns' Wood London, she has few if any financial responsibilities. She is wondering how to invest her annual bonuses and prefers bonds to equities.

B. Keith is a fifty-eight-year-old soon-to-be retired dentist. He has paid-off his mortgage and his children are independent. He is a widower. He is hoping to sell his dental practise to the new junior colleague for approximately £300K. He is wondering how to invest the windfall and prefers bonds to equities.

As background, you may assume the following: It is the beginning of January, 2021. The rate of inflation is expected to be 2% throughout this year. But increased government deficits and a stronger economy are expected to push the rate of inflation higher. According to the Bank of England, the inflation rate is expected to be 3% in 2022 and 4% in 2023 and 5% in 2024 and continue at this rate thereafter. The real rate of interest on Government Treasury bonds is 2% and not expected to change. The maturity premium grows by 10% per annum. So, for example, as the Treasury rate is 2% in 2021, it is expected to be 2.2% in 2022, excluding the inflation premium. One Year Treasury Bonds are paying therefore 4%- and Two-Year Bonds, 5.2%. AA Corporate Bonds have a credit spread of 150 basis points, so for example, if Treasury Bonds are paying 4% in 2021, then AA Bonds have a Yield of 5.5% and 6.7% in 2022.

On Corporate Bonds of the same maturity and Yield may have different mixes of discount to redemption price (face or "Par" value) and the coupons regularly paid. For your two clients, what would you recommend in the mix of discount to Par and Coupon? Who should have most of the return in the discount and who should have most of the return in the Coupon? Please explain your reasoning.