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


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% per year for the next 2 years or in a security that matures

in 1 year but pays only 6% 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%, as opposed to investing in the 2-year security paying

8%? Provide numerical support for your answer. Which theory of term

structure have you supported in your answer?

 







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