David is considering buying two bonds in order to service a payment due in 5 years. Bond A is a 6 year bond with 4% annual coupon selling at par (100%). Bond B, with similar credit rating, is a 3 year zero coupon bond selling at 90.19%.

a. Should you believe that the 1 year rate of the same credit rating will go up to 5% and stay there throughout 5 years and assuming that you can reinvest all the coupons received at the same 5% rate, which bond is a better 5 year investment? Show your working. (Hint: Assuming that you can invest in odd amount of par value, down to a dollar.)

b. David is a conservative investor and would like to minimize the interest rate risk. What do you think he will do? Please explain.