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by Joel Spolsky
Thursday, May 19, 2005

Wall Street Survival 101

You have $100,000 to invest. Which government bond should you invest in?

Bond A, B or C?

Bond A pays 4.15%. If you buy this bond, you'll get a check for $4150 in interest at the end of every year for 10 years. With your last check, you'll get your $100,000 back.

Bond B pays 4.5%. You'll get a check for $4500 at the end of every year for 30 years, then with your last check, you'll get your $100,000 back.

Bond C pays even more! It's 4.75%, w00t. you will get $4750 at the end of every year for 10 years, then get your original investment back, unless the government decides they want to keep your money for a little longer, in which case you'll get another 20 years of $4750 before you get your money back.

Bond C is a little more complicated so let me explain. On the tenth anniversary, the government gets to decide whether to pay you your $100K back and owe you nothing, or keep your $100K for another twenty years and keep paying you the interest. The point being, the choice is up to the government.

But either way, with Bond C, you're getting MORE interest every year, whether they decide to keep your money for 10 years or 30.

So, it's stupid to buy bonds A or B, right? Bond C is obviously the better choice.

Right?

Hints: assume that you're a left-handed avocado farmer and therefore don't pay any tax. So ignore the tax implications. Then, assume that all the bonds are equally sound, backed by the "full faith and credit of the United States" which, in the financial world, means there is absolutely no chance of default. This is not a trick question.

The answer tomorrow.

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