a. Assume Bill believes with 100% certainty that the inflation rate will be 0.250% over the...

a. Assume Bill believes with 100% certainty that the inflation rate will be 0.250% over the next 2 years. If Bill wants a 2-year investment, should he buy the Treasury note/bond or TIPS? And why?

b. Assume Bill believes with 100% certainty that the inflation rate will be 0.250% over the next 5 years. If Bill wants a 5-year investment, should he buy the Treasury note/bond or TIPS? And why?

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Expert Solution

a. Assume Bill believes with 100% certainty that the inflation rate will be 0.250% over the next 2 years. If Bill wants a 2-year investment, should he buy the Treasury note/bond or TIPS? And why?

For a 2-year investment, Bill should buy the Treasury note because the maturity of treasury note is between 1 and 10 years. So, Bill can buy a treasury note that matures in 2 years.

The maturity of Treasury bonds is between 10 and 30 years.

The maturity of TIPS are 5, 10, and 30 years. So, Bill cannot buy a Treasury bond or a TIPS for a 2-year investment.

b. Assume Bill believes with 100% certainty that the inflation rate will be 0.250% over the next 5 years. If Bill wants a 5-year investment, should he buy the Treasury note/bond or TIPS? And why?

For a 5-year investment, Bill shoudl buy the TIPS because it provides the hedge against the inflation and there are TIPS with 5-year maturity.

The maturity of Treasury bonds is between 10 and 30 years. So, bill should not buy this for 5-year investment.

Althogh, Treasury notes have a maturity of 5-years they do not give protection against the inflation. So, bill should not buy Treasury notes.

jeff jeffy answered 1 year ago

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