Question

The 30-day T-bill yield is currently 3.10%. You also know that

the inflation premium today is 1.80%, the liquidity premium is
0.25%, the maturity risk premium is 0.33% for bonds with 5 years to
maturi

Answer 1

When calculating a bond's present value with an 8% interest rate, it would be $2,944.44 and it would be $2,825.93 with an 11% discount rate.

Step-by-step explanation:

For a simple two-year bond with a principal amount of $3,000 and an interest rate of 8%, the annual interest is $240 (which is $3,000 × 8%). The present value of this bond can be calculated by discounting the future cash flows to present terms. If the discount rate is 8%, the present value (PV) of the bond's first-year interest payment is $240 / (1 + 0.08) = $222.22, and the PV of the second year's interest and principal repayment is ($240 + $3,000) / (1 + 0.08)^2 = $2,722.22. Summing these up gives us a total PV of $2,944.44.

Let's recalculate if the interest rates rise and the new discount rate is 11%. The PV of the first-year interest payment becomes $240 / (1 + 0.11) = $216.22, and the PV of the second-year payment is ($240 + $3,000) / (1 + 0.11)^2 = $2,609.71. The total PV at this higher discount rate is $2,825.93.

This example uses the present value formula to show how the valuation of future cash flows from a bond changes with variations in the interest rate or discount rate.