James is a rational investor wishing to maximize his return over a 20-year perio

Question

James is a rational investor wishing to maximize his return over a 20-year period. The current yield curve is inverted with one-year rates at 5.00% and 20-year rates at 3.50%. James will invest in the lower-rate 20-year bonds if:

A) he thinks rates will fall in the future and locking in long-term rates today may provide the highest long-run average return.

B) he thinks rates will rise in the future and locking in long-term rates today may provide the lowest long-run average return.

C) he thinks rates will remain flat at 5% in the future and locking in long-term rates today will prevent him from appearing greedy to those without this investment opportunity.

D) James has no idea what to do and should just skip this question.

Explanation / Answer

A) he thinks rates will fall in the future and locking in long-term rates today may provide the highest long-run average return.

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