Potential risks associated with riding yield curve strategy

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Reference no: EM131056279

Suppose the current annualized spot rates are as follows:

6 months 2%

12 months 2%

18 months 4%

Assume semi-annual compounding and semi-annual coupon payment

(a) An investor has an investment horizon of six months. She can invest her money in two ways. First, buy a 6-moth zero-coupon bond with a par of $1000 and hold it until maturity. Second, buy an 18-month zero-coupon bond with par of $1000 and sell it 6 months later. The investor expects that the spot rates will stay the same 6 months from now. Which investment strategy would the investor choose if she prefers a higher expected holding period return? Explain the potential risks associated with the riding the yield curve strategy.

Reference no: EM131056279

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