Your expectation of future interest rate in the second year E1r2, 6%, is less than the forward rate in the second year 1f2, 8%. What would you do? Your holding period (or investment period or length of your investment) is two years. The one-year spot rate, 0r1 , is 5%.

You are risk-averse, but believe your expectation is correct. Hint: Forward rates are used to price bonds today.

Group of answer choices

a. Invest in a one-year note and wait till one year later to invest in another one-year note one year from now. Annualized geometric rate of return over the next two years is 13%.

b. Invest in a two-year zero-coupon security and sell after two years. Annualized geometric rate of return over the next two years is 6.49%.

c. Invest in a one-year note and wait till one year later to invest in another one-year note one year from now. Annualized geometric rate of return over the next two years is 9.99%.

d. invest in a two-year zero-coupon security and sell after two years. Annualized geometric rate of return over the next two years is 4.99%.

Which statement about a corporate floating-rate security is correct? The benchmark market rate of return used for pricing is T-bill rate.

I. Modified duration of floating-rate security equals the time to next coupon reset (or coupon change) date.

II. The price of the floating-rate security on the next coupon reset date is already known even if there are drastic reductions in credit worthiness of the issuer or borrower.

III. Investor’s required rate of return to discount cash flows of floaters will never change. The required credit risk premium in the required rate of return would not change over the life of the floating rate security even if the company’s credit risk has worsened.

IV. Price of floating rate security would be at par theoretically on coupon-reset dates even when spot and forward rates change in the future, and there is no change in creditworthiness of company. Assume no transaction costs.

Group of answer choices

I and IV only

I and III only

IV only

II, and III only

I and II only

Answer rating: 100% (QA)

The detailed answer for the above question is provided below The correct answer is a Invest in a oneyear note and wait till one year later to invest i... View the full answer