Below is a set of current (t = 0) prices on a set of zero-coupon bonds. The face value on all of these bonds is $1000. The prices below are quoted per $1000 in face value. In answering the following questions, assume that you can buy fractions of a bond.

Bond Price

1-year zero 950

2-year zero 900

3-year zero 860

4-year zero 790

Also assume, for simplicity, that each of these bonds matures in exactly a multiple of a year from now (now = t = 0)

You have $20,000 and want to make an investment that will allow you to have a down payment on a house in exactly two years. Consider the following two alternative strategies:

1. You can invest in the default-free 3-year zero-coupon bond and sell it after two years(t = 2).

2. You can invest in the default-free 2-year zero-coupon bond.

Consider the second strategy (simply invest in the two-year zero coupon bond). How much money will you have at t = 2 to use a down payment? Does you answer depend upon what the one-year yields turn out to be at t = 2? Why or why not.