Question
You are considering 1-year investments in U.S. Treasury Strips at 1, 2, or 3 years to maturity. The face value for all Strips is $100.
You are considering 1-year investments in U.S. Treasury Strips at 1, 2, or 3 years to maturity. The face value for all Strips is $100. The current term structure of spot rates is below:\ \ Maturity Spot rate 1Y 2.25%\ 2Y 2.0%\ 3Y 1.8% \ \ For each scenario below, run a return attribution analysis for buying 1-, 2- and 3-year Strips, and break down the returns into the original yield, the roll down, and the interest rate risk components. How do these components depend on the maturity of the invest- ment, and on changes in interest rates? If you only care about expected returns, which Strip should you buy?\ Scenario 1. You expect all the spot rates to stay the same. Scenario 2. You expect all the spot rates to go up by 0.5%. Scenario 3. You expect all the spot rates to go down by 0.5%.
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