Consider at time t = 0 a flat 5% yield-to-maturity curve. A portfolio manager has money to invest over a 5-year horizon. He anticipates an interest rate increase by 1% in 1 year. Instead of buying directly a 5-year bond (Scenario 1), he buys a 1-year bond, holds it until maturity and buys in 1 year a 4-year bond (Scenario 2). Suppose now that his anticipation is correct:

Suppose now that the yield-to-maturity curve remains stable at 6% over the next four years. We are able to calculate the annual total return of his investment over the 5-year period in the two cases, assuming that he has reinvested the intermediary cash flows he has received at an annual rate of 6%.

Answer rating: 100% (QA)

To calculate the annual total return of the investment over the 5year period in the two scenarios well consider the cash flows received from the bond ... View the full answer