If you expect the yield curve to invert next year, with spot rates for maturities of...

If you expect the yield curve to invert next year, with spot rates for maturities of 10-years and above falling and spot rates for maturities less than 10-years rising. Given your forecast, explain which of bond Bond A or Bond B you would recommend for a long position over the upcoming year: Bond A -discount bond with a duration of 12-years and YTM of 5%; Bond B -coupon rate of 10%, a duration of 12-years, and a YTM of 5%.

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Expert Solution

Bond A will have coupon rate less than 5% and Bond B has a coupon rate of 10%. If the duration of the a lower coupon bond is the same as the higher coupon, it implies that the higher coupon bond has a longer maturity. Therefore Bond B has higher maturity. Since yield will decrease for long term bonds and price of that will increase, we would want a bond that has the longer maturity. As the yield will fall for both the bonds given they have maturity of more than 10 years, we need to find the bond which rises the most. When yields fall, price of bond rises. Highest duration bond exhibits the highest rise in price. Duration increases with decrease in coupon. Therefore, Bond B has higher duration and hence choose Bond B

jeff jeffy answered 2 years ago

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