Yield to Maturity You are considering investing $1000 for a three year period...
ID: 2715112 • Letter: Y
Question
Yield to Maturity
You are considering investing $1000 for a three year period...
You are considering investing $1.000 for a three-year period, beginning January 1.19% and ending December 31. 1998. The market offers only zero-coupon bonds maturing in one. two or three years. Looking into your crystal ball, you see the following term structure by date of purchase: What is the maximum accumulated value of your investment at the end of three yean, assuming that you hold any bonds that you buy until maturity?Explanation / Answer
Answer:
Zero Coupon Bonds is a bond that is issued at a deep discount to its face value but pays no interest.
It renders profit at maturity when the bond is redeemed. NO interest payment during the year. An investor only get profit at maturity when the Zero Coupon Bond is redeemed.
So, in the given question, we have to analysis three different situation where an investor get maximum accumulate amount from investing $1000 at beginning in Zero Coupon Bond.
Calculation of Accumulated Amount in different situation:
Situation 1: Investment in One-Year Bond @ 3% on Maturity
Maturity Value on 31/12/1996 = $1000 (1+0.03) = $1030
Maturity Value on 31/12/1997 = $1030 (1+0.03) = $1060.90
Maturity Value on 31/12/1998 = $1060.90 (1+0.03) = $1092.73
Accumulated Value on 31/12/1998 of Investment under One-Year Bond = $1092.73
Situation 2: Invest in Two-Year Bond @ 4% and after two year invest maturity amount in one year bond @3%
Maturity Value of Investment from Two-Year Bond on 31/12/1997 = $1000 (1+0.04) = $1040
Invest $1040 further in One-Year Bond @ 3%, Investor will get amount on 31/12/1998 = $1040 (1+0.03) = $1071.20
Accumulated Value on 31/12/1998 (under situation 2) = $1071.20
Situation 3: Invest for 1 year in One-Year Bond @ 3% and thereafter invest maturity amount in Two-Year Bond @ 6%
Maturity Value on Investment from One-Year Bond on 31/12/1996 = $1000 (1+0.03) = $1030
Invest $1030 on 1/1/1997 into Two-Year Bond @ 6%, and investor will get after two year on 31/12/1998 = $1030 (1+0.06) = $1091.80
Accumulated Value on 31/12/1998 (under situation 3) = $1091.80
Situation 4: Invest in 3 Year Bond @ 3%
Accumulated value on 31/12/1998 = $1000 (1+0.03) = $1030
Analysis
After analyzing all the above 4 Situations, Situation 1 gives highest accumulated value of investment.
Hence, the maximum accumulated value of investment at the end of three year is $1092.73
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