(a) A government bond is issued, promising to pay the bearer £1000 in five years’ time. The prevailing market rate of interest is 7%. What price would you expect to pay now for the bond? What would its price be after two years? If, after two years, the market interest rate jumped to 10%, what would the price of the bond be?

(b) A bond is issued which promises to pay £200 per annum over the next five years. If the prevailing market interest rate is 7%, how much would you be prepared to pay for the bond? Why does the answer differ from the previous question? (Assume interest is paid at the end of each year.)