Question

1. The price of a bond with no expiration date is originally $1,000 and has a fixed annual interest payment of $150. If the price of the bond then falls by $100, what will be the interest rate yield to a new buyer of the bond?

17.8%

16.7%

15%

11.2%

2. Which of the following statements is correct?

a. For a given real interest rate, the nominal interest must decrease if expected inflation increases.

b. For a given nominal interest rate, the real interest will decrease if inflation decreases.

c. For a given expected inflation rate, the nominal interest must increase if real interest decreases.

d. For a given real interest rate, the nominal interest must increase if expected inflation increases.

Answer 1

Answer:

1]

When the price of the bond with the no expiration date is $1,000 and pays an annual interest payment of $150, then the interest rate yield or effective interest rate yield was

Interest rate = Fixed payment amount / Bond price

Interest rate = 150 / 1000 = 0.15 = 15%.

When price of bond falls to $100, then the effective interest rate is

Interest rate = 150 / 900 = 16.67%

So correct option is 2) 16.67 percent

So the interest rate yield to a new buyer of the bond is 16.67%

2]

d. For a given real interest rate, the nominal interest must increase if expected inflation increases.

Reason:

Real Interest rate = Nominal Interest rate -Inflation rate

Or Nominal Interest rate = Real Interest Rate + Inflation rate

So if the rate of inflation increases nominal interest rate must increase for real interest rate to remain constant.

answered by: anonymous