Economics 330 – Money and Banking
Spring 2008
Dr. Neri
Problem Set 2 – Due within the first 5 minutes of lecture on Tuesday February 26, 2008. Late
submissions will not be accepted. You must show your calculations.
1) You are offered a 10year government bond with face value of $1,000. The bond entitles you to
receive a coupon payment of $100 per year for ten years. You will receive the first payment one year
from today. You are certain that all ten payments will be made in full and on time. The current
interest rate is 10%. How much would you be willing to pay today for this bond?
Why?
No calculation is need for this question. The coupon rate = $100/$1,000 = .10 = 10%. You are
told the current market interest rate = 10%. So the bond sells at par (face value).
2) Congratulations! You just won the lottery! You can elect to receive your prize in one of four
payment streams:
(i) $1,000,000 now
(ii) $1,500,000 at the end of five years
(iii) $60,000 per year in perpetuity, with payments made at the end of each year (so your first
payment comes one year from today)
(iv) $150,000 per year for the next ten years, with payments made at the end of each year (so your
first payment comes one year from today)
Suppose the annual interest rate is 5% with certainty and in perpetuity. Calculate the present value of
each of the four payment options (i.e., in today’s dollars). Rank for four options from most to least
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 Spring '08
 NERI
 Economics

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