Question

Rank the following assets from the lowest level to the highest level of (i) transaction costs, (ii) risk, (iii) liquidity. Ties are acceptable for items that have indistinguishable rankings.
a. a bank deposit with a guaranteed interest rate
b. a share of a highly diversified mutual fund, which can be quickly sold

Answer 1

Answer:

i. the transaction cost for bank deposit is lower than diversified mutual funds

bank deposit- lower

diversified mutual fund - higher

ii. In terms of risk

   bank deposit - lowest risk

   diversified mutual fund- higher than bank deposit

iii.  based on liquidity

     Diversified mutual fund is less liquid than bank deposit

     diversified mutual fund--  lowest

      bank deposit-  highly liquid ( higher)

Explanation:

bank deposit is cash and thus can easily be converted to cash . Cash has a higher liquidity ranking than any other near cash items. Mutual funds commissions are usually higher than bank's charges as the commission covers fees payable to the fund managers who are usually experts. The risk profile for bank deposit is lower than that of mutual funds whose value can fluctuate based on market prices of equities or instruments where the fund managers invest the funds. Guaranteed interest on bank deposit is already determined through out the tenor of the deposit. The certainty is higher than that of the well diversified mutual fund whose value can vary based on market conditions.

Answer 2

Answer:

1) The transaction cost of both he bank deposit and mutual fund are almost equal as transaction in both can be made by visiting a branch or using internet banking or brokering.

2) The risk for the bank deposits are lower thank mutual funds because even thought the mutual fund is highly diversified, its value can still decline because of changes in market or some market crash like the 2008 recession, where as the money in the bank remains intact

3)  The liquidity is higher for bank deposits because money can be withdrawn instantly, whenever the depositor wants, where as the liquidity for mutual funds is a bit lower as it takes a couple of business days to make transactions.

Explanation: