Suppose you have a 5 year investment horizon and you are considering one of the following three bonds:

Bond Duration Maturity

Bond 1 8 years 10 years

Bond 2 5 years 7 years

Bond 3 3 years 6 years

a. If you believe interest rates will fall and you wish to earn more than the promised yield which of the three bonds above should you choose? Explain why in terms of the change in sale price and reinvestment income.

b. If you believe interest rates will increase and you wish to earn more than the promised yield which of the three bonds above should you choose? Explain why in terms of the change in sale price and reinvestment income.

c. If you do not know which way interest rates may move and you wish to ensure you earn the promised yield which of the three bonds above should you choose? Explain why in terms of the change in sale price and reinvestment income.