Question

The Office of the Treasurer maintains an investment pool for several quasi-independent governments, such as housing authorities and development boards, affiliated with a city. Michelle Ruiz, a senior manager in the treasurer's office, recently became aware that the treasurer has been investing pool funds in risky derivatives and has been leveraging the funds by financing the purchase of long-term securities with short-term loans. Because of a sustained rise in interest rates over the past year, the market value of the portfolio is considerably below the contributions of pool participants. If the pool participants were to learn of the losses, it is virtually certain that some would withdraw from the fund immediately, thereby prompting an overall run on the pool.
As long as the losses are kept quiet, it is more than probable that the interest rates will soon decline and that the portfolio will recover its value. Indeed, within the last week the Federal Reserve Board announced a reduction in interest rates and the value of the portfolio rebounded slightly. By contrast, a run on the pool would ensure that virtually all participants incur substantial losses.
Shortly after Ruiz learns of the losses, she is making a presentation to the media as to the operations of the pool.
During a question-and-answer session she is asked how the pool has performed over the last several years. She explains (truthfully) that over the long term, investment returns have been well above average. She is uncertain, however, as to whether she should add anything as to its short-term results.



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  • CreatedAugust 13, 2014
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