Question

On March 11, the existing or current (spot) 1-, 2-, 3-, and 4-year zero-coupon treasury security rates were as follows:

(a) 1r₁ = 0.75%, 1r₂ = 1.35%, 1r₃ = 1.75%, 1r₄ = 1.90%
(b) 1r₁ = 1.35%, 1r₂ = 0.75%, 1r₃ = 1.90%, 1r₄ = 1.75%
(c) 1r₁ = 1.75%, 1r₂ = 0.75%, 1r₃ = 1.35%, 1r₄ = 1.90%
(d) 1r₁ = 1.90%, 1r₂ = 1.75%, 1r₃ = 1.35%, 1r₄ = 0.75%

Answer 1

The present value of a bond can be calculated using the present value formula. Changes in interest rates can significantly affect the present value of a bond.

Step-by-step explanation:

A bond's present value can be calculated using the present value formula. In this case, the bond initially pays $240 in interest after the first year and $3,240 (principle + interest) at the end of the second year. To calculate its present value, we discount these future cash flows using the discount rate of 8%. The present value of the bond is found to be $3,000.

If the discount rate rises to 11%, we apply the same calculation method to recalculate the present value. The new present value is found to be $2,691.28.

This example demonstrates how changes in interest rates affect the present value of a bond.