Now is t = 0. You have $20,000 that you are willing to investing for 3 years.
You are considering three different potential strategies. They are:
Strategy 1: Invest in a 3 year zero with a current (i.e., t = 0) yield to maturity of 3 percent.
Strategy 2: Invest in a 1-year zero with a current (i.e., t = 0) yield to maturity of 1 percent; then next year (when the current 1-year zero matures) invest in a two year zero at whatever the yield to maturity on two-year zeros are then (at t = 1).
Strategy 3: Invest in a 5 year zero with a current yield to maturity of 3.5 percent and sell these bonds in three years (at t = 3).
If the yield curves at t = 1 and t = 3 are as shown below, which of these three strategies will turn out the best? That is, after 3 years, which strategy will generate the largest amount of money?
t = 1 Yield Curve: t = 3 Yield Curve: .
Time to maturity YTM Time to Maturity YTM
(in years) (in years)
1 .02 1 .02
2 .022 2 .025
3 .025 3 .035
4 .030 4 .045
