# Question

You expect interest rates to rise on five-year bonds by 1 percent per year over the next three years from their artificially low rate of 2 percent. Currently you can buy the following securities at the yields listed below. You invest $10,000 into each bond and spend the income from the portfolio. Refer to Table 18-11 for the structure of this problem.

1-year bond 0.50%

2-year bond 1.00%

3-year bond 1.50%

4-year bond 1.75%

5-year bond 2.00%

a. Build a five-year bond ladder with the above data and compute the annual rate of return.

b. At the end of the first year, reinvest the $10,000 that matures into a new five-year bond and compute the return on the portfolio.

c. At the end of the second year, reinvest the $10,000 that matures into a new five-year bond and compute the return on the portfolio.

d. Finally, at the end of the third year, rates have peaked and you reinvest the $10,000 that matures into another five-year bond. Compute the yield on your portfolio.

e. How much did the return on the last portfolio differ from the return on the beginning portfolio?

1-year bond 0.50%

2-year bond 1.00%

3-year bond 1.50%

4-year bond 1.75%

5-year bond 2.00%

a. Build a five-year bond ladder with the above data and compute the annual rate of return.

b. At the end of the first year, reinvest the $10,000 that matures into a new five-year bond and compute the return on the portfolio.

c. At the end of the second year, reinvest the $10,000 that matures into a new five-year bond and compute the return on the portfolio.

d. Finally, at the end of the third year, rates have peaked and you reinvest the $10,000 that matures into another five-year bond. Compute the yield on your portfolio.

e. How much did the return on the last portfolio differ from the return on the beginning portfolio?

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