i. ii. Many investors from 2002-2016 (right side of exhibit) invested less in the bond markets during that time because they remembered nominal interest rates being much higher in 1987-2001 (left side of exhibit) and did not believe they were getting paid enough interest. Use the exhibit below to answer the following questions: Exhibit 1.6 Three-Month Treasury Bill Yields and Rates of Inflation 3-Month T-bills (%) Rate of Inflation (%) 4.40 4.40 4.65 Year 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 5.78 6.67 8.11 7.50 5.38 3.43 3.33 4.25 5.49 5.01 5.06 4.78 4.64 5.82 3.40 6.11 3.06 2.90 2.75 2.67 2.54 3.32 1.70 1.61 2.70 3.40 1.55 Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 3-Month T-bills (%) 1.61 1.01 1.37 3.16 4.73 4.48 1.37 0.15 0.14 0.04 0.06 0.02 0.02 0.02 0.20 Source: Federal Reserve Bulletin, various issues; Economic Report of the President, various issues. Rate of Inflation (%) 2.49 1.87 3.26 3.42 2.54 4.08 0.09 2.72 1.50 2.96 1.74 1.51 0.76 0.73 2.07 On Jan 2, 2007 you are sitting with a client and recommending they invest a portion of their investment portfolio in 3-Month T-Bills. You say that the yield on the 3-Month T-Bill is 4.73% as of year-end 2006. Your client objects and says in 1990 the yield was 7.50% and they do not want to accept such a lower return today. Calculate the "Real Return" of the 3-Month T- Bill in 1990 and compare it to 2006. Use these calculations and the concept of real returns to address your client's objection. Explain why and how you would change your nominal required rate of return for stocks if you expected the rate of inflation to go from its level in 1990 to its level in 1991. Give an example of what would happen if you did not change your required rate of return under these conditions.