Compare a two yearbond with two successive one year bonds n a situation in which

Question

Compare a two yearbond with two successive one year bonds n a situation in which an investor buys a one year bond today and then another one year bond when the first matres. Suppose that the tw year bond has an interest rate of 8 percent each year.

a) Now consider the pattern of interest rates on the one year bonds listed below and explain hether an investor should buy the two year bond o the one year bondtoday, assuming that the only thing that matters to the investor is the amount of money he has at the end of the wo years. In each case, how mch would an investor have at the end of the two yers in he invested one thousand dollars today?
i) The one year interest rate today is 7 percent; the one year interst rate will be 9 percent one year from now
ii) The one year interest rate today is 5 percent; the one year interest rate will be 11 percent one year from now
iii) The one year in terst rate today is 3 percent; the one year interest rate will be 13 percent one year from now
iv) The one year interest rate tody is 0 percent; the one year interest rate will be 16 percent one year from now

b) From these results, is it reasonable to compare the average interst rates on alternative financial statements?

Explanation / Answer

ii) The one year interest rate today is 5 percent; the one year interest rate will be 11 percent one year from now

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