As a U.S. pension funds financial advisor, one of your tasks is to prescribe the allocation of

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Question:

As a U.S. pension fund’s financial advisor, one of your tasks is to prescribe the allocation of available funds across money market securities, bonds and mortgages. Your philosophy is to take positions in securities that will benefit most from your forecasted changes in economic conditions. As a result of a recent event in China, you expect that in the next month investors in China will reduce their investment in U.S. Treasury securities and shift most of their funds into Chinese securities. You expect that this shift in funds will persist for at least a few years. You believe this single event will have a major effect on economic factors in the United States, such as interest rates, exchange rates, and economic growth in the next month. Because the prices of securities in the United States are affected by these economic factors, you must determine how to revise your prescribed allocation of funds across securities.

Answer these questions:

How will U.S. interest rates be directly affected by the event, holding other factors equal?
How will economic growth in the United States be affected by the event? How might this influence the values of securities?
Use your answer to question 1 only, explain how prices of U.S. money market securities, bonds, and mortgages will be affected.

Assume that, for diversification purposes, you prescribe that at least 20 percent of an investor’s funds should be allocated to money market securities, 20 percent to bonds, and 20 percent to mortgages. This allows you to allocate freely the remaining 40 percent across the same securities. Based on the information you have about the event, prescribe the proper allocation of funds across the three types of U.S. securities. (Assume that the entire investment will be concentred in U.S. securities). Defend your prescription.
Suppose that, instead of reducing the supply of loanable funds in the United States, the event in China increased demand for them. Would your assessment of future interest rates be different? What about your general assessment of economic conditions?