Question

You currently own $100,000 worth of 1 year bonds and $100,000 worth of 10 year bonds. You believe that interest rates are going to decrease tomorrow. Based on your beliefs, to maximize the benefit to you, TODAY you should ....... (Ignore the cost of trading the bonds)
A. sell your 1 year bonds and buy an additional $100,000 of the 10 year bonds and expect a capital gain
B. sell your 1 year bonds and buy an additional $100,000 of the 10 year bonds and expect to avoid a capital loss
C. sell your 10 year bonds and buy an additional $100,000 of the 1 year bonds and expect a capital gain
D. sell your 10 year bonds and buy an additional $100,000 of the 1 year bonds and expect to avoid a capital loss

Answer 1

Answer:

C. sell your 10 year bonds and buy an additional $100,000 of the 1 year bonds and expect a capital gain

Explanation:

If you expect a decrease in the interest rate it means that each bond that you hold today will have a higher price tommorrow because of the decline in the interest rates.

It occurs because bond coupons are fixed and if market expectations are lower interest rates, then the adjustment occurs in the bond price to make the adjustments to a lower bond's yield.