Jim Lytle, a financial adviser, recommends that his clients invest in gold. Spec

Question

Jim Lytle, a financial adviser, recommends that his clients invest in gold. Specifically, he is advising a client to invest $100,000 to purchase 175 ounces of gold bullion, with the expectation of holding the gold for a period of one year before selling it. The client points out that the futures price for 175 ounces of gold to be delivered in one year is $104,000, which represents a 4% return on the $100,000 investment, while the one-year Treasury yield is currently 5%. “Wouldn’t it be better,” the client asks, “if I sold 175 ounces of gold today for $100,000, while purchasing a forward contract to purchase the gold in one year at a price of $104,000? I could then invest the $100,000 in 5% Treasury bonds maturing in one year.”

Analyze the returns for the client’s proposed strategy. What is your recommendation?

Why might the two alternatives offer different returns?

Explanation / Answer

1)The client's proposal strategy is that to sell out the gold yielding 4% in one year to invest in 5%treasury bonds yielding 5% in the same year. Thus having a higher return of $1000 in the year. Clients' strategy is recommended.

2)The two alternatives offers different returns because the return on the bullion or gold is always less than the treasury yield, being it backed by the U.S. Government.

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