Making the assumption of no compounding interest, suppose you purchase a perpetu

Question

Making the assumption of no compounding interest, suppose you purchase a perpetuity bond from Blue Sun Corporation for $2,000 with an annual coupon rate of 3%. Specify all answers to the nearest dollar, and assume a discount rate equal to that of the current interest rate. What is the yearly return on your $2,000 investment? Number Changes inthe economy push interest rates up from 3% to 5%. For how much can you sell your bond following this change in market interest rates? Number Suppose that interest rates instead change from 3% to 1%. For what price will you be able to sell your bond following this change in market interest rates? Number

Explanation / Answer

(1) Yearly return = $2,000 x 3% = $60

(2) Selling price of a perpetual bond = Bond yearly return / Interest rate

When interest rate = 5%,

Selling price = $60 / 0.05 = $1,200

(3)

When interest rate = 1%,

Selling price = $60 / 0.01 = $6,000

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