Making the assumption of no compounding interest, suppose you purchase a perpetuity bond from CosoNostra Pizza Inc. for $4,000 with an annual coupon rate of 3% . Specify all answers to the nearest dollar, and assume a discount rate equal to that of the current interest rate.

Required:
a. What is the yearly return on your $4,000 investment?
b. Changes in the economy push interest rates up from 3% to 5%. For how much can you sell your bond following this change in market interest rates?
c. Suppose that interest rates instead change from 3% to 1%. For what price will you be able to sell your bond following this change in market interest rates?

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anthougo anthougo · Answer 1 · 2021-12-12T16:19:12+01:00

a. The yearly return on the $4,000 investment is $120 ($4,000 x 3%).

b. The selling price of the perpetuity bond when interest rate moves from 3% to 5% is $2,400 ($120/0.05).

c. The selling price of the perpetuity bond when interest rate moves from 3% to 1% is $12,000 ($120/0.01).

Data and Calculations:

Perpetuity bond receivable =$4,000

Annual coupon rate = 3%

Change in annual interest rate =5% or 1%

The present value of a perpetuity (price) is given by the formula = D/Discount rate

where D = Interest per year

and Discount rate = 5% or 1%

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