Question

Your friend promises you a perpetuity of $1 every year, which starts in year 1. However, your friend is an absent-minded guy, paying you $2 at year 10 but no payment at year 9. Except for these two years, in other years, the payment is always $1. Which of the following statements is true?

Select one: a. your friend is better off for his being absent-minded

b. you are better off for his being absent-minded

c. there is no difference for his being absent-minded

d. no enough information to make decision

e. none of the above

Bond A has a coupon rate of 9%, with a three-year maturity and a face value of $1,000. If the discount rate now or future is 9%, and you want to buy bond A now, what is the price you have to pay now (P0)?

Select one:

a. $1,000.00

b. $1,200.00

c. $1,250.00

d. cannot be decided

e. none of the above

Answer 1

The correct answer is

a. your friend is better off for his being absent-minded

The value of perpetuity is equal to present value of cash flows

Since Year 9 payment is made in Year 10, the present value decreases

Making is better for the friend and worse for you

The answer is

a.$1000

Since coupon rate is same as required return i.e. yield to maturity, the bond will trade at par

The bond trades at premium when the yield is lower than the coupon rate

And at discount when the yield is higher than the coupon rate