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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

Bond A pays $8,000 in 20 years. Bond B pays $8,000 in 40 years. (To keep things simple, assume these are zero-coupon bonds, which means the $8,000 is the only payment the bondholder receives.)

a. If the interest rate is 3.5 percent, what is the value of each bond today? Which bond is worth more? Why? (Hint: You can use a calculator, but the rule of 70 should make the calculation easy.)

b. If the interest rate increases to 7 percent, what is the value of each bond? Which bond has a larger percentage change in value?

c. Based on the example above, complete the two blanks in this sentence: “The value of a bond [rises/falls] when the interest rate increases, and bonds with a longer time to maturity are [more/less] sensitive to changes in the interest rate.”

Subpart (a)

To determine

Calculating the value of bonds.

Explanation

Required number of year can be calculated by using the following formula.

Number of years to double = 70Growth rate  (1)

Substitute the respective values in equation (1) to calculate the required number of years to double the investment with the given interest rate.

Number of years to double=703.5=20

The investment is doubled in the 20 years

Subpart (b)

To determine

Calculating the value of bonds.

Subpart (c)

To determine

To determine: Value of bonds.

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