a) You hold a consol that pays a coupon C in perpetuity. The current interest rate is i, and the average expectation in the market is that this will remain unchanged. What will be the price of the consol today? [1%] (b) In the next period however, the interest rate changes unexpectedly to i 0 . What is the new price of the bond? If the bond is sold at the beginning of that next period, what is the yield from the consol? Does the yield increase or decrease if i 0 > i? [4%] (c) Suppose alternatively that the market expects that the interest rate will change to i 0 after the initial period. What is the initial value of the consol, and what is the yield from selling it after one period? [5%]
(a) You hold a consol that pays a coupon C in perpetuity. The current interest rate is i, and the average expectation in the market is that this will remain unchanged. What will be the
(b) In the next period however, the interest rate changes unexpectedly to i 0 . What is the new price of the bond? If the bond is sold at the beginning of that next period, what is the yield from the consol? Does the yield increase or decrease if i 0 > i? [4%]
(c) Suppose alternatively that the market expects that the interest rate will change to i 0 after the initial period. What is the initial value of the consol, and what is the yield from selling it after one period? [5%]
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