Bond A is a one-year instrument and Bond B is a two-year instrument. The bonds have very similar default risk and income tax treatment. Currently, the following yields exist on these bonds. Bond Yield A 3.253.25% B 3.503.50% Part 2 If (holding all else equal) the interest rate that investors expect on one-year instruments next year suddenly increasesincreases to 4.254.25%, investors will become ▼ more likely to sellmore likely to sell neither more likely to buy nor more likely to sellneither more likely to buy nor more likely to sell more likely to buymore likely to buy two-year bonds today. This will cause the yield on two-year bonds today to ▼ decreasedecrease increaseincrease remain unchangedremain unchanged .
Added by Christopher W.
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Bond A has a yield of 3.25%, and Bond B has a yield of 3.50%. Since Bond B has a longer maturity, it typically offers a higher yield to compensate for the additional risk and uncertainty over the longer time frame. Show more…
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