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:

Symbolic

Pertaining to the use of symbols or symbolism to represent ideas, beliefs, or objects, often to convey complex concepts in an abstract manner.

Appetites

Natural desires or cravings, especially for food.

Erratic

Characterized by lack of consistency, regularity, or uniformity; unpredictable.

2 to 3 Years

A developmental stage in toddlers marked by significant growth in motor skills, language acquisition, and personal social awareness.