It's April 1, 2017, and you want to buy a house. the housing market is spiking and you're hesitant to enter the market because of rumours that the market is a bubble that's about to pop. You have $200k saved for a down payment but you decide to put off the purchase for one year to see if the market stabilizes. the bank manager suggest you purchase a 3 month CD that will pay you 0.4% annually (so 0.1% for the 3 month period). you ask him what you'll do after the 3 months is over and he suggests that you do this four times in a row to preserve your financial capital. you scoff at the suggestion and ask for another opinion. he suggests a one year bond. it pays 1.5% (so $1000 invested would return $1015 in one year). you ask about a 5 year bond and he says it pays a 2% yield (2% coupon rate). what about a 30 year bond. he says the newly issued 30 year bonds are paying 2.5% and you could always sell either the 5 year or 10 year bonds in the secondary market after a year has passed. you decide to go with the long bond option.
On April 2 (next day) the BoC raises the bank rate by .25% (25 basis points). all the rates in the economy increase accordingly (including the CD rates). the BoC then continues to raise the bank rates by .25% every 3 month (by the time a year passes all rates are 1% higher). Calculate how much you have saved for your house down payment considering each 5 scenarios:
a) you bought the CD's: the 1st CD paid. 1% for the first 3-month CD, then .35% for the second 3-month CD, then .6% for the 3rd, etc. : $______
b) you bought the one year bond and held it until maturity: $______
c) you bought the 5 year bond and sold it immediately after collecting the first coupon payment (remember the economy-wide rate is now 1% higher than when you bought the bond, so one year bond yeilds have followed suit): $______
d) You bought the 30 year bond and sold it immediately after collecting the 1st coupon payment: $______
e) you bought the 30 year bond and sold it immediately BEFORE the first coupon payment (the rates are also 1% higher at time of sale in this case too): $______