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The current zero-coupon interest rates for terms 4 and 5 years are 7.4% and 7.5% per annum respectively. Meredith wishes to invest today and has an...
The current zero-coupon interest rates for terms 4 and 5 years are 7.4% and 7.5% per annum respectively. Meredith wishes to invest today and has an investment horizon of 4 years. Specifically, her target is to have $100,000 in 4 yearsâ time. She is considering two investment strategies: (i) buying the 4 year bond and (ii) investing the amount calculated for the first strategy but instead buying the 5-year bond and selling the bond after 4 years have passed.
Required:
a) How much will Meredith need to invest today if she implements strategy (i)?
Marks: 2
b) Suppose Meredith decides to implement strategy (ii). What 1-year interest rate in the fourth year, will see Meredith exceed her target? Marks: 5
c) How would the proponents of the expectations hypothesis interpret this result? How would proponents of the liquidity premium hypothesis interpret this result?
