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21_liquidity preference theory

# 21_liquidity preference theory - 410 HW#21 e 1 As of end of...

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410 HW #21 1. As of end of year 2010: % 3 %, 3 %, 3 1 1 2 1 = = = + e t t t YTM YTM YTM Face value of all bonds: 1000 All bonds for this problem pay zero coupon. Strategy 1: Buy 1 year bond, roll over to another 1 year bond. Strategy 2: Buy 2 year bond (matures at end of 2012) a. What is the current price of the 1-year bond? What is the current price of the two- year bond? b. Suppose at the end of 2011 you need to liquidate and get out of either strategy. Suppose your prior expectation of future spot rates was correct, so that as of the end of 2011 %. 3 1 = t YTM Calculate the returns from liquidating strategy 1 and strategy 2. c. Suppose at the end of 2011 you need to liquidate and get out of either strategy. Suppose your prior expectation of future spot rates was incorrect , so that as of the end of 2011 %. 5 1 = t YTM Calculate the returns from liquidating strategy 1 and strategy 2. d. In light of your answers above, explain why investors would probably not be willing to buy the two year bond at the end of 2010 if its YTM is only 3%.

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