Which of the following statements about the relationship between interest rates and bond prices is true?
- There is an inverse relationship between bond prices and interest rates.
- There is a direct relationship between bond prices and interest rates.
- The price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates. (Assuming that coupon rate is the same for both)
- The price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates. (Assuming that the coupon rate is the same for both)
Answer: I and IV only
Consider a bond with a face value of $1,000, a coupon rate of 8%, a yield to maturity of 9%, and ten years to maturity. This bond's duration is:
- 8.7 years
- 7.6 years
- 7.1 years
- 6.5 years
Answer: 7.1 years
PV = $865.80; Duration = [(73.39) + 2(67.33) + 3(61.77) + 4(56.67) + 5(51.99) + 6(47.70) + 7(43.76) + 8(40.15) + 9(36.83) + 10(33.79)]/(935.82) = 7.1 years
Real Rate of Interest
If the nominal interest rate per year is 12% and the inflation rate is 3%, what is the real rate of interest?
- None of the above
1 + rreal = (1 + rnominal)/(1 + rinflation) = 1.12/1.03 = 1.087; rreal = 8.7%
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