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You are considering purchasing a consol that promises annual payments of $4. a. If the current interest rate is 5 percent, what is the price of the consol?b. You are concerned that the interest rate may rise to 6 percent. Compute the percentage change in the price of the consol and the percentage change in the interest rate. Compare them.Your investment horizon is one year. You purchase the consol when the interest rate is 5 percent and sell it a year later, following a rise in the interest rate to 6 percent. What is your holding period return?

Respuesta :

TomShelby

Answer:

a.-The bond is selling at 80% of the face value

b.- the rate increase by 20% and the price decrease by 13.33%

Holding period return: -11.66%

Explanation:

a.- A consol means a perpetual bond.

If the market rate is higher than this bond rate, the price will be lower than face value:

face value x 4% = coupon payment

coupon payment / 5% = market value

0.04/0.05 = 0.8

b.- market rate of 6%

0.04/0.06 = 66.67%

Decrease in price: 13.33%

Increase in rate: 0.06 / 0.05 = 20%

holding period return:

[tex]\frac{return}{investment}[/tex]

The return will be compose of the dividend yield and the price variation for the year:

If we purchase at 80. Then receive 4 and sale for 66.67 our return will be:

4 dividend yield + (66.67-80) price change = -9.33

Investment: 80

return: -9.33/80 = 11.66%