Currently the term structure is as follows:

One-year spot rate 2%

Two-year spot rate 3%

Three-year spot rate 4%

You have a one-year investment horizon one-, two-, and three-year zero coupon bonds are available.

a. Which bonds should you buy if you strongly believe that at year-end the term structure remains

unchanged (i.e., one, two, and three year spot rates remain the same)?

b. Redo part (a) assuming at year-end the term structure shifts as follows:

One-year spot rate 6%

Two-year spot rate 7%

Three-year spot rate 8%

c. What conclusion(s) can you make by comparing the results of parts (a) and (b) above?