It is 8 January 2021. You are provided with information about the yields of Treasury Bonds (paying annual coupons) and Treasury STRIPS (ie., zero coupon bonds) in Exhibit 1 and Treasury (inflation-protected) Index Bonds in Exhibit 2. You plan to borrow a 2-year loan beginning one year from now (i.e., 8 January 2022). Assume that short sellings of Treasury coupon bonds and Treasury STRIPS are allowed.

Required: Answer both parts of the question in the space provided. [word limit: 150]

1. What treasury securities (i.e., type and maturity) in Exhibit 1 will you use to construct the 2-year loan begining one year from now? And describe the steps involved so that you can lock in the loan interest rate today. [Hint: no calculation is required]
2. Ignore part 1 of this question. A friend suggested that you can borrow at a negative interest rate based on the negative yields displayed in Exhibit 2. Comment on your friends suggestion. [Hint: no calculation is required]

Exhibit 1 On-the-run yield curve on Treasury annual coupon bonds Pure yield curve on Treasury Maturity (years) (YTM) STRIPS 1 0.040% 0.040% 2 0.065% 0.067% 3 0.110% 0.113% 4 0.285% 0.290% 5 0.430% Maturity (years) 1 5 6 Exhibit 2 Coupon rates 1.25% 3% 0.75% 2.50% 2% Treasury Indexed Bonds (YTM) -1.435% -1.310% -1.050% -0.745% -0.445% 9 14