Question
You are given the following information on the bond market: Money available on January 1, 2013: $1,000 Interest rates on January 1, 2013, on bonds
You are given the following information on the bond market:
Money available on January 1, 2013: $1,000 Interest rates on January 1, 2013, on bonds of different maturities: one year, 4 percent; two years, 5 percent; three years, 5.5 percent; four years, 6 percent
Note: Consider these to be bonds that compound the interest at the rate given, that is, the three-year bond pays $1,000 3 1.0553 at maturity
Expected future interest rates on one-year bonds:
January 1, 2014: 6.5 percent
January 1, 2015: 7 percent
January 1, 2016: 9 percent Investment horizon: four years, ending January 1, 2017.
What should an investor buy to yield the largest stream of expected income over the period from January 1, 2013, to January 1, 2017?
How would your answer to above change if there is a $10 transactions cost for every bond purchased? In other words, if an investor has $1,000 now, she can spend only $990 on a bond because $10 goes for transactions costs. Each time she buys a new bond, she incurs the $10 fee.
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