(a) What is the present value of a \(\$ 1000\) bond which pays \(\$ 50\) a year
for 10 years, starting one year from now? Assume the interest rate is \(5 \%\)
per year, compounded annually.
(b) Since \(\$ 50\) is \(5 \%\) of \(\$ 1000\), this bond is called a \(5 \%\) bond.
What does your answer to part (a) tell you about the relationship between the
principal and the present value of this bond if the interest rate is \(5 \%\) ?
(c) If the interest rate is more than \(5 \%\) per year, compounded annually,
which is larger: the principal or the present value of the bond? Why is the
bond then described as trading at a discount?
(d) If the interest rate is less than \(5 \%\) per year, compounded annually,
why is the bond described as trading at a premium?