5. Pure expectations theory: Multi-year periods Megan would like to invest a certain amount of...
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5. Pure expectations theory: Multi-year periods
Megan would like to invest a certain amount of money for three years and considers investing in (1) a one-year bond that pays 3 percent, followed by a two-year bond that pays the forward rate, or (2) a three-year bond that pays 8 percent in each of the next three years. Megan is considering the following investment strategies:
Strategy A: Buy a one-year bond that pays 3 percent in year one, then buy a two-year bond that pays the two-year forward rate in years two and three.
Strategy B: Buy a three-year bond that pays 8 percent in each of the next three years.
If the two-year bond purchased one year from now pays 9 percent annually, Megan will choose .
Which of the following describes conditions under which Megan would be indifferent between Strategy A and Strategy B?
The rate on the two-year bond purchased one year from now is 10.590 percent.
The rate on the two-year bond purchased one year from now is 11.120 percent.
The rate on the two-year bond purchased one year from now is 9.107 percent.
The rate on the two-year bond purchased one year from now is 9.743 percent.
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