3. Frannie must decide whether to buy a one-year bond today and another one a year from now, or buy a two-year bond today. In which of the following scenarios is she better off taking the first action? The second action?
This year, the interest on a one-year bond is 4%; next year, it will be 10%. The interest rate on a two-year bond is 5%.
Frannie is better off buying a one-year bond today and a one-year bond next year because this allows her to get the higher interest rate one year from now.
This year, the interest rate on a one-year bond is 4%; next year, it will be 1%. The interest rate on a two-year bond is 3%.
Frannie is better off buying a two-year bond today because it gives her a higher interest rate in the second year than if she bought two one-year bonds.