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Three years from now is expected to have an interest rate

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Suppose that a risk-neutral investor has a choice between buying a one-year bond paying 5 percent today, a two- year bond paying 5.4 percent today, a three-year bond paying 5.8 percent today, or a four-year bond paying 6.2 percent today, if a one-year bond purchased one year from now is expected to have an interest rate of 6 percent, a one-year bond purchased two years from now is expected to have an interest rate of 7 percent, and a one-year bond purchased three years from now is expected to have an interest rate of 8 percent.

Explain with the help of suitable calculations, which of the following would the investor decide to do?

A) The investor will purchase a one-year bond today, followed by three successive one-year bonds.

B) The investor will purchase a two-year bond today, followed by two successive one-year bonds.

C) The investor will purchase a three-year bond today, followed by a one-year bond.

D) The investor will purchase a four-year bond today.

Reference no: EM131020120

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