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Chapter 16: Q.1 (page 368)

Let's denote the price of a non-maturing bond (called a consol) as Pb. The equation that indicates this price is Pb=Ir, where I is the annual net income the bond generates and r is the nominal market interest rate.

a. Suppose that a bond promises the holder 500$ per year forever. If the nominal market interest rate is 5 per cent, what is the bond's current price?

b. What happens to the bond's price if the market interest rate rises to 10 per cent?

Short Answer

Expert verified

a. The bond's current price $10000

b. The bond's price if the market interest rate rises to10%will fall by$5000

Step by step solution

01

introduction

A non-maturing bond or interminability is a non-redeemable bond with no development date. These bonds are treated as value, not obligation and pay a constant flow of interest instalments for eternity.

02

explanation part (a)

Given,

I =$500

nominal market interest rate r =5%

We know,

role="math" localid="1651664386923" Po=Ir⇒5000.05=10000

The bond's current price is$10000

03

explanation part (b)

if the market interest rate rises to 10per cent,

P0=lr⇒5000.10=5000

The bond's price if the market interest rate rises to10% will fall by$5000

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Most popular questions from this chapter

Assume that the following conditions exist :

a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.

b. The money multiplier is 4.

c. The planned investment schedule is such that at a 4percent rate of interest, investment is \(1400billion. At 5percent, investment is \)1380billion.

d. The investment multiplier is 5.

e. The initial equilibrium level of real GDP is \(19trillion.

f. The equilibrium rate of interest is 4percent.

Now the Fed engages in contractionary monetary policy. It sells \)2billion worth of bonds, which reduces the money supply, which in turn raises the market rate of interest by 1 percentage point. Determine how much the money supply must have decreased, and then trace out numerical consequences of the associated increase in interest rates on all other variables mentioned.

Suppose that each 0.1percentage point decrease in the equilibrium interest rate induces a \(10billion increase in real planned investment spending by businesses. In addition, the investment multiplier is equal to 5, and the money multiplier is equal to 4. Furthermore, every \)20billion increase in money supply brings about 0.1percentage point reduction in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal.

a. How much must real planned investment increase if the Federal Reserve desires to bring about a $100billion increase in equilibrium real GDP ?

b. How much must he money supply change for the Fed to induce the change in real planned investment calculated in part (a) ?

c. What dollar amount of open market operations must the Fed undertake to bring about the money supply change calculated in part (b) ?

Suppose that to finance its credit policy, the Fed pays an annual interest rate of 0.50 per cent on bank reserves. During the course of the current year, banks hold $1 trillion in reserves. What is the total amount of interest the Fed pays banks during the year?

Assuming that the Fed judges inflation to be the most significant problem in the economy and that it wishes to employ all of its policy instruments except interest on reserves, what should the Fed do with its policy tools?

Understand the equation of exchange and its importance in the quantity theory of money and prices.
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