Bond prices and interest rates

# Bond prices and interest rates - Bond prices and interest...

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Bond prices and interest rates Example On January 1, 2000, Tanya purchases a newly issued, 2-year government bond with a principal amount of \$1,000. The coupon rate (interest rate) on the bond is 5 percent, paid annually. Hence, Tanya, or whoever owns the bond at the time, will receive a coupon payment of \$50 (5 percent of \$1,000) on January 1, 2001, and \$1,050 (a \$50 coupon payment plus repayment of the original \$1,000 lent) on January 1, 2002. On January 1, 2001, after receiving her first year’s coupon payment, Tanya decides to sell her bond to raise the funds to take a vacation. She offers her bond for sale in the bond market. How much can she expect to get for her “used” bond if the prevailing interest rate in the bond market is 6 percent? If the prevailing interest rate is 4 percent? The price of a “used” bond at any point in time depends on the prevailing interest rate. Suppose first that, on January 1, 2001, when Tanya takes her bond to the bond market, the prevailing interest rate on newly issued 1-year bonds is 6 percent. Would another

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## This note was uploaded on 03/18/2008 for the course ECON 304L taught by Professor Staff during the Spring '07 term at University of Texas.

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Bond prices and interest rates - Bond prices and interest...

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