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Currently the term structure is as follows:
One-year spot rate 2%
Two-year spot rate 3%
Three-year spot rate 4%
You have a one-year investment horizon one-, two-, and three-year zero coupon bonds are available.
a. Which bonds should you buy if you strongly believe that at year-end the term structure remains
unchanged (i.e., one, two, and three year spot rates remain the same)?
b. Redo part (a) assuming at year-end the term structure shifts as follows:
One-year spot rate 6%
Two-year spot rate 7%
Three-year spot rate 8%
c. What conclusion(s) can you make by comparing the results of parts (a) and (b) above?
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