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Chapter 16: Q.1 (page 368)

Let's denote the price of a non-maturing bond (called a consol) as Pb. The equation that indicates this price is Pb=Ir, where I is the annual net income the bond generates and r is the nominal market interest rate.

a. Suppose that a bond promises the holder 500$ per year forever. If the nominal market interest rate is 5 per cent, what is the bond's current price?

b. What happens to the bond's price if the market interest rate rises to 10 per cent?

Short Answer

Expert verified

a. The bond's current price $10000

b. The bond's price if the market interest rate rises to10%will fall by$5000

Step by step solution

01

introduction

A non-maturing bond or interminability is a non-redeemable bond with no development date. These bonds are treated as value, not obligation and pay a constant flow of interest instalments for eternity.

02

explanation part (a)

Given,

I =$500

nominal market interest rate r =5%

We know,

role="math" localid="1651664386923" Po=Ir鈬�5000.05=10000

The bond's current price is$10000

03

explanation part (b)

if the market interest rate rises to 10per cent,

P0=lr鈬�5000.10=5000

The bond's price if the market interest rate rises to10% will fall by$5000

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