The yield curve currently observed in the market is as follows: y1 = 7%, Y2 = 8%, and y3 = 9%. You are trying to decide between buying a two-year bond (Bond A) and three-year bond (Bond B), each of which is default-risk free and pays annual coupons of 8% per year. You strongly believe that yield curve in one year will become flat at 9%. Which one of the two bonds should you buy today if you plan to sell this bond in exactly one year (right after you receive the first coupon payment)? Assume interest is compounded annually, and each bond has a face value of $1,000. Bond B Neither bond -- The expected total return of both bonds will be negative if interest rates increase to 9% in one year Bond A Both bonds provide the same return over a one year investment horizon A portfolio that invests 50% of your wealth in each bond provides the highest total expected return
The yield curve currently observed in the market is as follows: y1 = 7%, Y2 = 8%, and y3 = 9%. You are trying to decide between buying a two-year bond (Bond A) and three-year bond (Bond B), each of which is default-risk free and pays annual coupons of 8% per year. You strongly believe that yield curve in one year will become flat at 9%. Which one of the two bonds should you buy today if you plan to sell this bond in exactly one year (right after you receive the first coupon payment)? Assume interest is compounded annually, and each bond has a face value of $1,000. Bond B Neither bond -- The expected total return of both bonds will be negative if interest rates increase to 9% in one year Bond A Both bonds provide the same return over a one year investment horizon A portfolio that invests 50% of your wealth in each bond provides the highest total expected return
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:The yield curve currently observed in the market is as
follows: y1 = 7%, Y2 = 8%, and yz = 9%. You are
trying to decide between buying a two-year bond (Bond
A) and three-year bond (Bond B), each of which is
default-risk free and pays annual coupons of 8% per year.
You strongly believe that yield curve in one year will
become flat at 9%.
Which one of the two bonds should you buy today if you
plan to sell this bond in exactly one year (right after you
receive the first coupon payment)? Assume interest is
compounded annually, and each bond has a face value of
$1,000.
Bond B
O Neither bond -- The expected total return of both bonds will
be negative if interest rates increase to 9% in one year
Bond A
Both bonds provide the same return over a one year
investment horizon
A portfolio that invests 50% of your wealth in each bond
provides the highest total expected return
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