Ans PS No2 S08

Ans PS No2 S08 - Economics 330 Money and Banking Spring...

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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 10-year 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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Ans PS No2 S08 - Economics 330 Money and Banking Spring...

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