Question

7. Suppose a three year government bond is purchased at $1,000 when the market rate of interest is 10%, which pays a coupon rate of 10%. Determine the market value of the bond if the market rate of interest decreases to 8% right after the bond is issued. Comment on the relationship between the market rate of interest and the market value of bonds and who gains from the fall in the market interest rate of interest

Answer 1

ANSWER:-

Suppose a three year government bond is purchesed at $ 1000 when the market rate of interest is 10% which pays a coupon rate of 10% .Determine the market value of the bond if the market rate of interest decrease 8% right after the bond is issued.

Here,

Intial face value =$1000

Interest rate =10%

Coupon rate =10%

Time 3 year,

Now if interest rate falls to 8% we have,

Present value=$\large \frac{100}{1+.08}+\frac{100}{(1+.08)^2}+\frac{1100}{(1+.08)^3}$Present value=$

1051.54

As the rate decreases The price of a bond increase.The bond holder gains from such a decrease in interest rates.