Question

Suppose you received a gift of $2000 cash on your 21st birthday. Further suppose you used it to purchase a bond with no expiration date that pays annual interest of $100.

a. What is the annual yield rate on your bond?

b. What will be the market price of your bond if the interest rate on newly issued bonds of similar risk rises to 6%?

c. Alternatively, what will be the market price of your bond if the interest rate on newly issued bonds of similar risk falls to 4%? d. Complete the following: "Bond prices and interest rates are _____ related."

Answer 1

Part A

We know that the annual yield rate of bond is the percentage return on bond. The yield is,

in percentage terms is,

Part B

Here given the competitive bond is 6%. so nobody will interest to buy our bond unless it yields 6%. So the price of bond falls by,

It is remain competitive.

Part C

The return of our bond is $100 at the price of $2000 yield of 5%. it is highly desirable compared to other assets of 4% Now the selling price may rise,

Part D

Bond prices and interest rates are inversely related