Suppose that you have $1,000 to invest in the bond market on January 1, 2018. You could
Question:
Suppose that you have $1,000 to invest in the bond market on January 1, 2018. You could buy a one-year bond with an interest rate of 4%, a two year bond with an interest rate of 5%, a three-year bond with an interest rate of 5.5%, or a four-year bond with an interest rate of 6%. You expect interest rates on one-year bonds in the future to be 6.5% on January 1, 2019, 7% on January 1, 2020, and 9% on January 1, 2021. You want to hold your investment until January 1, 2022. Which of the following investment alternatives gives you the highest return by 2022:
(a) Buy a four-year bond on January 1, 2018;
(b) Buy a three-year bond January 1, 2018, and a one-year bond January 1, 2021;
(c) Buy a two-year bond January 1, 2018, a one-year bond January 1, 2020, and another one-year bond January 1, 2021;
(d) Buy a one-year bond January 1, 2018, and then additional one-year bonds on the first days of 2019, 2020, and 2021?
Step by Step Answer:
Money Banking And The Financial System
ISBN: 1801
3rd Edition
Authors: R. Glenn Hubbard, Anthony Patrick O'Brien