Compare a Two-Year Bond with Two Successive One-Year Bonds, in Which

question 56

Essay

Compare a two-year bond with two successive one-year bonds, in which an investor buys a one-year bond today, then another one-year bond when the first matures.Suppose the two-year bond has an annual interest rate of 4 percent.
Consider the pattern of interest rates on the one-year bonds listed below and explain whether an investor should buy the two-year bond or the one-year bond today, assuming that the only thing that matters to the investor is the amount of money she has at the end of the two years; that is, she is risk neutral.In each case, how much would an investor have at the end of two years if she invested $1,000 today? Show your work.Round to the nearest penny ($0.01).In each case be sure to say which bond the investor would buy today.
a.The interest rate on a one-year bond today is 1 percent, and the interest rate on a one-year bond purchased in one year from now is 8 percent.

b.The interest rate on a one-year bond today is 2 percent; and the interest rate on a one-year bond purchased one-year from now is 6 percent.

c.The interest rate on a one-year bond today is 3 percent; and the interest rate on a one-year bond purchased one-year from now is 5 percent.

d.The interest rate on a one-year bond today is 5 percent; nd the interest rate on a one-year bond purchased one-year from now is 3 percent.

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Definitions:

Interaction

In statistics, it refers to a situation where the effect of one variable on a response variable differs depending on the level of another variable.

Sum of Squares

A statistical technique used to measure the variation among data points by summing the squared differences from the mean.

Error

The difference between a measured or predicted value and the true value, often used in the context of statistical or experimental analysis.

SSE

Stands for Sum of Squares due to Error, a measure used in statistics to quantify the dispersion of data points.