Question 1 answer

Before I go and make you understand the difference between the two such investments or the
terminologies that your professor has used to define them, let me start defining what investment is.
Investment is the process of giving out money, and in return expect the same amount of money to
be returned along with a margin.

Now, giving out money holds a bunch of things, it can be a deposit with the bank, buying stocks,
bonds or any government securities. Moreover, the corporates or firms also make investments in
purchasing machineries, land, building, plants and factories (giving out money), and using these
assets to produce goods & services. These produced goods and services can be sold to consumers
outside, and generate revenue to cover the initial investment along with a profit, which the
organizations have made initially.

The firms always expect the investment would fetch a higher return, however, this is not always
being the case. It is quite obvious that the firm would incur a loss in the future after investing in the
assets above. The loss can go up to any limit, which might vanish the entire investment, which the
firm has made. However, it still holds the definition for investment, because the organization would
always expect profit to go well above its initial investment irrespective of whether the firms end-up
having loss at the end.

The degree of loss and profit may also vary with the amount of risk you hold before making any
investment. Every investment comes with a risk, except the investments related to the trusted
parties such as government that has zero risk involved. Risk and return always go hand-in-hand, the
more the risk the higher the return. However, in every case the firms would always expect return
from investment, if in case they think we would incur a loss, then they would not invest in such a
project, hence no investment.

Question 2 answer

My advice to her would be to observe the movement in the interest rate in the debt market. It is a
fundamental principle of finance and economics that bond prices and interest rates move in
opposite directions.

Price changes associated with a given interest rate change is larger for bonds with a longer maturity
than for bonds with a shorter maturity. If a bond is due to mature in short time, a change in its
interest rate will have small effect on the bonds value. On the other hand, if the principle is not to be
repaid for many years, the same interest rate change will have a significant effect on the bonds
value.

In the case of my Aunt Sally, she has bonds of different maturities which means she might
experience both. Since I have anticipate an increase in the interest rate in the near future, it is most
likely that Aunt Sally would make a loss. Price changes due to interest rate fluctuates are another
source of risk for lenders who invest in bonds.

My advice to Aunt Sally in order for her to abstain loss, she should not get out of the investment
quickly because if the interest rate increases after the investor purchased the bond, its price will
decline and the investor will take a loss if he or she has to get out of the investment quickly. It’s
important if Sally holds the bond to the maturity. She will only experience loss if she has to sell early
at a depressed price.