Question

Deborah would like to invest a certain amount of money for two years and considers investing in a one-year bond that pays 4% and a two-year bond that pays 7%. Deborah is considering the following investment strategies:

Strategy A: Buy a one-year bond that pays 4% and in one year buy another one-year bond.
Strategy B: Buy a two-year bond that pays 7% this year and 7% next year.

If the one-year bond that Dina can purchase in one year pays 9%, Deborah will choose:_______

Answer 1

If the one-year bond that Dina/Deborah can purchase in one year pays 9%, Deborah will choose:_______

Strategy B.

Step-by-step explanation:

a) Data:

Interest on one-year bond = 4%

Interest on a two-year bond = 7%

Investment strategies:

Strategy A: Buy a one-year bond that pays 4% and in one year buy another one-year bond.

Strategy B: Buy a two-year bond that pays 7% this year and 7% next year.

b) Although choosing a fixed income investment is a conservative strategy because returns are generated from low-risk securities that pay predictable interest, this strategy may be preferred by Deborah instead of another that pays at variable interest rates. The variable-interest bond will need to pay higher varying interest rates to be attractive to Deborah. Paying 4% in year one and another 9% in year two will not make the bond investment more attractive than a straight two-year bond that pays at 7% per year.