Problem 1. An investor buys a U.S. Treasury bond whose current yield to maturity is 10 percent. The investor is subject to a 33 percent federal income tax rate on any new income received. His real after-tax return from this bond is 2 percent. What is the expected inflation rate in the financial marketplace?
Problem 2. An investor wishes to ride the yield curve to higher profits on an investment of $1,000. He observes in the market a zero-coupon T-note with one year left to maturity yielding 5 percent and another zero-coupon T-note yielding 7 percent with two years to maturity. What investment strategy should he pursue? Show how this investment strategy would be superior to a simple buy-and-hold strategy. Under what conditions will this strategy succeed? When will it fail?
Problem 3. Repeat problem 2, but where the market interest rates are: 7 percent for the 1-year, zero-coupon bond and 5 percent for the 2-year, zero-coupon bond.