Question: Question 8 Consider a bond that promises to make coupon payments of $100 one year from now and $100 two years from now, and to

Question 8

Consider a bond that promises to make coupon payments of $100 one year from now and $100 two years from now, and to repay the principal of $1,000 three years from now. Suppose also that the market interest rate is 8 percent per year, and that no perceived risk is associated with the bond.

8.1 Compute the present value of this bond.

8.2 Suppose the bond is being offered for $995. Would you buy the bond at that price? What do you expect to happen to the bond price in the very near future?

8.3 Suppose the bond is instead being offered for $950. Would you buy the bond at that price? Do you expect the bond price to change in the near future?

8.4 If the price of the bond is equal to its computed present value from [8.1], what is the implied bond yield?

8.5 Explain why bond yields and the market interest rate tend to move together so that economists can then usefully refer to “the” interest rate.

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