Consider the case in which an investor holds a bond for a period of time longer than the duration of the bond, that is, longer than the original investment horizon.
a. If interest rates rise, will the return that is earned exceed or fall short of the original required rate of return? Explain.
b. What will happen to the realized return if interest rates decrease? Explain.
c. Recalculate parts (b) and (c) of problem 16 above, assuming that the bond is held for all five years, to verify your answers to parts (a) and (b) of this problem.
d. If either calculation in part (c) is greater than the original required rate of return, why would an investor ever try to match the duration of an asset with his or her investment horizon?