Question

Assume that you purchased a $1,000 perpetual bond (coupon payment is $50) and the interest rate on that bond declined from 5 percent to 2 percent. Thus,
A) the bond price increased by $1,500
B) you could sell this bond at a capital gain
C) at an interest rate of 2%, the speculative demand for money would increase
D) all of the above
E) none of the above

Answer 1

Answer:

D) all of the above

Explanation:

First find the present value for each alternative  using PV of perpetual cashflow formula;

PV = CF / rate

CF = 50

If rate= 5%;

PV = 50/0.05 = $1,000

If rate = 2%;

PV = 50/0.02 = $2,500

With these two calculations, we see that;

-the bond price increased by $1,500

-you could sell this bond at a capital gain, meaning you can sell it a higher price that what you bought it for.

-at an interest rate of 2%, the speculative demand for money would increase

Hence , all these choices are correct!