Jon wishes to invest $10,000 in U.S. Treasury securities for 10 years. He is considering the following investment strategies: 1) Buy a 10 years T-Note and hold it to maturity;2) Buy a 5 year T-Notes and upon maturity roll over the principal and interest into a second 5 year T-Note;3) Buy a Treasury with one year to maturity, and continuously roll over the investment in 1 year Treasuries for 10 years. The current yields are: 2% on the 1 year Treasury;4.25% on the 5 year T-Note; and 4.5% on the 10 year T-note.Jon's financial analysis indicates that market expectations are for the 1 year Treasury yield to rise by 50 basis points every year for the first five years and then remain unchanged for the next five years, and for the 5 year T-Note to be the same in five years as it is today.
1. Suppose that actual short rate remained unchanged during the entire 10 years, how would that affect to 10 year rate of return on investment (3)?
2. What would happen to the investment's 10 year rate of return if the one year rate continued to rise at 50 basis points per year for 5 through 10?
3. If the 5 year T-note yield fell 50 basis points after 5 years, how much would this reduce the 10 year rate of return on investment(2)?
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