Question

2. A risk-free bond has a face value of $500 in one year, the price of the bond today is $472.

a. What is the rate of return (yield) on the bond?

b. If the expected rate of inflation is 2%, what is the real interest rate?

3. a. Show the supply and demand for a given bond and show what will probably happen if the bond’s credit rating is downgraded from AA to A.

b. What happens to the rate of return on the above bond?

4. For each of the following, say whether or not it is counted (directly) as part of GDP.

a. Ringo buys a used car.

b. Ringo washes his car.

c. Ringo takes his car to a carwash.

d. Ringo buys new tires for his used car.

e. Ford buys new tires for use in new cars.

Answer 1

Due to presence of HOMEWORKLIB POLICY, I am answering one question.

2.

a. We have:

$Price(1+YTM)=FV$

$472(1+YTM)=500$

$YTM=\frac{500}{472}-1=0.0593$

where,

YTM = Yield till maturity

b.

If the expected inflation rate is 2%, real interest rate is given as:

$R=\frac{1+0.0593}{1+0.02}-1=0.0385$

or 3.85%.

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