I was talking to a friend recently and he asked me the following question.
If I have a device which perfectly (with 100% accuracy) predicts that both a bond (e.g. AAA rated government bond) and the shares of a listed company (e.g. Google) yield 5% over the next year. If I had US$1 million, which one should I invest in?
Although it seems kind of vague, I'm assuming that I have to sell both instruments after a year to realise the 5% return. My answer was the bond because the a government bond rated at AAA would be very unlikely to go bankrupt (although the country not being bankrupt might be implied by the yield) and bonds are usually less volatile. Further, I at least have a bit of recourse upon default vs shares. Upon giving him the answer, I was told that my answer wasn't totally correct. Does anyone think I'm missing anything? Also is there a way to model this vague question to back up my point of view?
EDIT: Taking into account coupons and dividends, maybe the bond is preferred iff coupon rate > dividend rate. Also, maybe I can forecast the bond YTM. Any ideas will eb appreciated.