If investors are not indifferent to whether they hold long-term or short-term securities,and need a liquidity premium to hold longer term securities,an investor who needs a liquidity premium of 0.25% per annum will expect to receive _______ on a two-year investment,given the following data:
(₀i₁) 8.46% per annum
(E₁i₁) 8.55% per annum

Question

Quizplus · Accepted Answer

To calculate the expected return on a two-year investment, we need to use the liquidity premium and the yields of the two securities.

Let's first calculate the yield on a one-year security: 
Yield on one-year security = [(1 + 8.46%) / (1 + 0.25%)] - 1 = 8.1968%

Now, we can calculate the expected yield on a two-year security: 
Expected yield on two-year security = [(1 + 8.55%) x (1 + 0.25%) / (1 + 8.1968%)^2] - 1 = 8.627%

Therefore, the answer is B, 8.63% per annum.

If Investors Are Not Indifferent to Whether They Hold Long-Term