assignment 4

# Pv15pv1522000 pv929152 the present value today is

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PV*(1+5%)+PV*(1+5%)^2=2000, PV=929.152 The present value today is \$929.152. b. A simple discount bond pays \$1000 in one year. Find the yield to maturity when the price of the bond is i. \$750 I=(F-P)/P P=750, i=(1000-750)/750=33.33% ii. \$900

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Econ 350 Winter 2012 Assignment 4 3 P=900, i=(1000-900)/900=11.11% iii. \$1000 P=1000, i=(1000-1000)/1000=0% What happens to the yield to maturity as the price of the bond increases? c. How much would investors be willing to pay for a perpetuity that that pays \$400 per year if interest rates are 2%? P=C/i=400/2%=20000 Willing to pay 20000 dollars 4. a. Assuming that each class day is one year, what were the yields to maturity for Series A and B bonds? Series A, market clearing price is \$8.00, the face value is \$12.00. The yield to maturity is i=(F-P)/P=(12-8)/8=50% Series B, market clearing price is \$10.00, the face value is \$12.00 The yield to maturity is i=(12-10)/10=20% b. What happened to the demand for bonds between Series A and B? According to the theory of asset demand, why? Bid number increased from 141 for series A to 172 to series B. Lowest bid was 2 for A and 6 for B, people learned the lessons from the Series A and make a different bid for series B. When people bid for the series A bond, there were nothing to show as an example, so it is a blind bid, people just making a trial bid to see what other people think. But it is different for the series B bond, because we have a reference from the result of series A bond, so there have a feeling of what the market clearing price probably would be. So people raised the price, and the market clearing price raised up from \$8 to \$10. Also because the investment from Series A, we have different amount of money for the Series B bond. The theory of asset demand explains this perfectly. The theory of asset of demand is that demand for an asset is positively to wealth. And demand is negatively related to relative risk. The different wealth as different amount of
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