Question
One investor has a 3-year investment window and is considering two investment strategies. One choice is to invest in a 3-yr bond that has a
One investor has a 3-year investment window and is considering two investment strategies. One choice is to invest in a 3-yr bond that has a 10% coupon rate, annual payment, with par=1000. The other choice is to invest in a 1-yr bond and reinvest two more times in the 3-year window. Assume that the 1-yr bond has the same par value and the same coupon rate as the 3-yr bond. If at year 0, the market interest rate for both is 10%, and at year 1, the interest rate drops to 7%, and at end of year 2, the interest rate drops further to 6%, what will be the cash inflows of the two investment strategies respectively? What does this example indicate? show the comparison of the reinvestment rate risk of a long-term bond vs. a short-term bond. Please work on this comparison (show the calculation and specify cash flow in a timeline)
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