You currently have $15,000 that you plan to use to buy a car. You prefer a new car, but you are also open to a used car. Either way you will pay cash. The cost of a new car today (in 2012) is $22,500, but the cost for new versions of this car is projected to rise by 2% per year through 2017. Instead of a new car, you could buy a 2012 model later in the used-car market. The price of the 2012 model is expected to decline by 15% per year through 2017. You plan to invest your $15,000 into BBB-rated bonds, but you are not sure whether you should invest in successive one-year bonds, or in longer-term bonds. The five-year yield curve for zero coupon bonds rated BBB is given below to help you make your decision.
Term 1 year 2 years 3 years 4 years 5 years
YTM 10.00% 11.00% 12.00% 13.00% 14.00%
Assuming implied forward rates are the best estimates of future one-year rates, how many years before you can expect to pay cash for a used car if you invest in successive one-year bonds?
a. One year b. Two years c. Three years d. Four years
What is the implied forward rate for the last year of this investment?
a. 10.00% b. 12.01% c. 14.03% d. 16.05% e. None of the above