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Suppose the annualized spot rates are as follows 6 months 2% 12 months 4%
(a) Calculate the price of the 6-month Treasury bill with the par value of $100 and the price of the 12-month (zero-coupon) Treasury bill with the par value of $100. Note that the interest is compounded every six months.
(b) An investor has an investment horizon of 6 months. He can invest his money in two ways. First, buy the 6-month Treasury bill and hold it until maturity. Second, buy the 12-month Treasury bill and hold it for 6 months. The investor believes that the spot rates will stay the same 6 months from now. Which investment strategy should the investor choose if he prefers high expected holding period returns?
(c) If 6 month from now the 12-month spot rate increases to 9% and the 6-month spot rate increases to 8%, what are the realized holding period returns on the two investment strategies?
(d) What are the potential risks associated with the riding the yield curve strategy?
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