Question

The British government has a consol bond outstanding paying per year forever. Assume the current interest rate is per year.

a. What is the value of the bond immediately after a payment is​ made?
b. What is the value of the bond immediately before a payment is​ made?

Answer 1

a. The value of the bond immediately after a payment is made is the same as the payment divided by the interest rate. For example, if the bond pays £100 per year and the current interest rate is 5%, the value of the bond immediately after a payment is made is £100 / 0.05 = £2000.

b. The value of the bond immediately before a payment is made is the same as the value of the bond immediately after a payment is made minus the coupon payment. For example, if the bond pays £100 per year and the current interest rate is 5%, the value of the bond immediately before a payment is made is £2000 - £100 = £1900.