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NEW QUESTION: 1
A 10-year government zero coupon bond is currently yielding 6.4%. If in 10 years, you expect a two year government zero coupon bond to provide a yield of 10.7%, what must the yield be on a 12-year zero coupon bond today in order for you to be indifferent between the 10-year bond and the 12-year bond?
A. 7.1%
B. 7.7%
C. 8.4%
Answer: A
Explanation:
To be indifferent, both securities must yield the same total dollar amount at the end of the investment horizon, which in this case is 12 years.
Option I: Buy a 10-year bond and then a 2-year bond. Option II: Buy a 12-year bond.
When indifferent: Option I = Option II
(1.064)10 (1.107)2 = (1 + x)12= 7.1%
where x is the yield on the 12-year bond.

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