Sam Collins had been investing for several years. Most of his investments were in the stock market. For several years, he made substantial capital gains. As his success grew, he began to invest in riskier shares.
Last year, after a serious market downturn, Collins suffered significant losses that left him with cash resources of only $50,000. He was unable to use all of the capital losses for tax purposes and was left with unused net capital losses of $70,000. The substantial losses have shattered his confidence in the stock market. He has requested that his broker find him a secure bond in which to invest his remaining $50,000.
Collins is not destitute, as he has a substantial annual salary of $130,000. His broker has suggested a five-year corporate bond that will provide an interest return of 13%, and at the same time, he has tried to convince Collins to remain in the stock market but to acquire only high-level blue-chip shares. In this vein, he has suggested, as a possible alternative to the bond, a common-share investment in a utility company that historically provides an annual dividend return (eligible dividends) of 5% as well as capital growth of 6%.
In addition, the broker has indicated that any annual cash returns can be invested in treasury bills earning 13% annually.
Required:
1. Which investment will best help Collins recover his lost capital? (Use a five-year period for your analysis.)
2. What rate of return must the bond offer in order for it to yield the same return as the share investment?