2008SPRING-HW3 - ECO 320L-HW3 Due March 6 2008 Classtime 1...

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ECO 320L-HW3 Due March 6, 2008 Classtime 1. Problems 1, 3, 4, and 8 from chapter 8. 2. Questions about asset pricing. Definition: The face value (also known as the par value) of a bond is the amount of money the bond will pay when the bond matures matures. (a) Consider a treasury bond that promises to pay $100 (i.e. $100 face value) one year from now. If the annual nominal interest rate is 6%, then what would be the price of this bond today? What would be to the price of this bond if the annual nominal interest rate decreases to 4%? What can you say about the relation between the interest rate and the price of a bond? (b) Consider a treasury bill that promises to pay $100 three years from now. What would be the price of the bond today if the annual nominal interest rate is 6%? Assume that you buy this bond today at this price. One year from today, the annual nominal interest rate goes down to 5% (say due to Fed’s cutting interest rates). What would be the price of the bond after the interest rate cut? If you sell this bond just after the reduction in interest rate, what would be the rate of return from your investment?
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