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Question: 1 what is the relationship between real interest rate nominal...

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1. What is the relationship between real interest rate, nominal interest rate and inflation rate?

2. What are the reasons for very high nominal interest rates in the 1980s?

3. Someone buys a 5 year government treasury bond at $P

t

a.

Can the price be above face value? Why?

b. Can the price be below face value? Why?

c.

If he/she wants to sell it after 2 years, will he/she makes a positive rate of return or

negative rate of return? Explain.

4. Consider the following bond purchased at $800 in 2018.

F=1000; C=100; N=5; P=800

a.

What is the yield to maturity? (This is equal to the market interest rate prevailing in

2018)

b. If the interest rate rises to 20% in 2019 what is the price of the bond?

(Solve the following equation: 0.2=(100+(1000-P)/5)/(1000+P)/2

c.

If the investor sold the bond in 2019 without holding till maturity did he/she make a

profit or a loss?

d. What is the rate of return in 2019?

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