5. Suppose the yield to maturity on a one-year zero-coupon bond is 5%. The yield to maturity on a two-year zero-coupon bond is 3%. (a) According to the Expectations Hypothesis, what is the expected one-year rate in the marketplace for year 2? (b) Consider an investor who is absolutely convinced that interest rates will not change so that the yield on a one-year bond will still be 5% this time next year. Which of these two bonds, the one-year zero coupon bond, or the two-year zero coupon bond, should this investor buy to maximize their one year return (under their strongly-held belief about future rates)?

Essentials Of Investments
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ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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5. Suppose the yield to maturity on a one-year zero-coupon bond is 5%.
The yield to maturity on a two-year zero-coupon bond is 3%.
(a) According to the Expectations Hypothesis, what is the expected one-year rate in
the marketplace for year 2?
(b) Consider an investor who is absolutely convinced that interest rates will not
change so that the yield on a one-year bond will still be 5% this time next year.
Which of these two bonds, the one-year zero coupon bond, or the two-year zero
coupon bond, should this investor buy to maximize their one year return (under
their strongly-held belief about future rates)?

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