You want to invest your savings of $20,000 in government securities for the next

Question

You want to invest your savings of $20,000 in government securities for the next 2 years. Currently, you can invest either in a security that pays interest of 8.0 percent per year for the next 2 years or in a security that matures in 1 year but pays only 6.0 percent interest. If you make the latter choice, you would then reinvest your savings at the end of the first year for another year. Why might you choose to make the investment in the 1-year security that pays an interest rate of only 6.0 percent, as opposed to investing in the 2-year security paying 8.0 percent? Provide numerical support for your answer. Which theory of term structure have you supported in your answer? Assume your required rate of return on the second-year investment is 11.0 percent; otherwise, you will choose to go with the 2-year security. What rationale could you offer for your preference? Why might you choose to make the investment in the 1-year security that pays an interest rate of only 6.0 percent, as opposed to investing in the 2-year security paying 8.0 percent? Provide numerical support for your answer. Which theory of term structure have you supported in your answer? If you choose the 2-year security, the value of your savings after the second year will be

Explanation / Answer

Amount to be invested = 20000

Option I Interest at the rate of 6%

Amount at first year end = 20000 * 6% = 1200

Reinvest and amount at second year end = 21200 * 6% = 22,472

Option II interest rate @ 8%

Amount at year end 2 = 20000*8% *2

= 23200

compounding theory is used in this answer.

Choose Investment option of 8% interest 2 year security

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.