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Based on your analysis of future inflation and its effect on future interest rates, you predict that short-term interest rates will rise over the next
Based on your analysis of future inflation and its effect on future interest rates, you predict that short-term interest rates will rise over the next year. In particular, you think that the 1-year and the 2-year rates will be higher than they are currently (as indicated by the data in Problem 2). More specifically, you think that the 1-year rate next year will be 3% (per annum) and the two-year rate will be 3.5% (per annum). You want to exploit your analysis to generate a return over 1 year (that is, the horizon of your investment strategy is one year). Based on your beliefs, you want to analyze the returns from two investment strategies: (1) investing in 2-year zeros and selling them early (in exactly one year), or (2) investing in 3-year zeros and selling them early (in exactly one year). Given your expectations about the 1-year and 2-year zero rates next year (in exactly one year), what are the returns you expect for each strategy? (8 points - 4 points each) Return from investing in the 2-year zeros and selling them next year = Return from investing in the 3-year zeros and selling them next year =_ Based on your analysis of future inflation and its effect on future interest rates, you predict that short-term interest rates will rise over the next year. In particular, you think that the 1-year and the 2-year rates will be higher than they are currently (as indicated by the data in Problem 2). More specifically, you think that the 1-year rate next year will be 3% (per annum) and the two-year rate will be 3.5% (per annum). You want to exploit your analysis to generate a return over 1 year (that is, the horizon of your investment strategy is one year). Based on your beliefs, you want to analyze the returns from two investment strategies: (1) investing in 2-year zeros and selling them early (in exactly one year), or (2) investing in 3-year zeros and selling them early (in exactly one year). Given your expectations about the 1-year and 2-year zero rates next year (in exactly one year), what are the returns you expect for each strategy? (8 points - 4 points each) Return from investing in the 2-year zeros and selling them next year = Return from investing in the 3-year zeros and selling them next year =_
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