Bond Prices and Interest
Economists argue that bond prices and interest rates are inversely related. On a piece of notebook paper, please use the following scenario to answer the questions. The government offers a $1,000.00 bond, paying 10% interest, for a period of one year. Show all work.
a. Please calculate the interest income for this bond.
b. Please determine the price of the bond in the secondary market, if prevailing interest rates fell from 10% to 9.5%. (hint: remember, the bond face value, interest, and maturity date cannot change, so when this bond purchaser remits the bond to the government, they will still be paid your response from number one)
c. Create an idealized bond and money market model to show this relationship. Describe the outcomes.
d. Starting from the original scenario, please calculate the price of this bond in the secondary market if the prevailing interest rate climbed from 10% to 10.5%.
e. Create an idealized bond and money market model to show the relationship from the scenario in (d). Describe the outcomes.
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