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Below is a set of current (t = 0) prices on a set of zero-coupon bonds. The face value on all of these bonds is $1000. The prices below are quoted per $1000 in face value. In answering the following questions, assume that you can buy fractions of a bond.
Bond Price
1-year zero 950
2-year zero 900
3-year zero 860
4-year zero 790
Also assume, for simplicity, that each of these bonds matures in exactly a multiple of a year from now (now = t = 0)
If you invested in a two-year bond and rolled over into a one-year bond at t = 2, what would the one-year yield at t = 2 have to be in order for you to be indifferent between that strategy and investing in the three-year bond at t = 0?
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