Wilma bought a 10-year $1000 bond when the interest rate was 5% per year. So her

Question

Wilma bought a 10-year $1000 bond when the interest rate was 5% per year. So her bond would provide her with $50 at the end of each of ten successive years; and the $1000 is also returned at the end of ten years. She has just collected her seventh annual payment on the bond.
Suppose now she wants to sell the bond because she is in need of money sooner than expected

a. Suppose the interest rate is still 5% and this is expected to continue for the remaining life of the bond. How much can she expect to sell her bond for?

b. Suppose the interest rate has increased to 10% and this is 10% rate is expected to continue for the remaining life of the bond. How much can she expect to sell her bond for?

Explanation / Answer

a) A 5% bond in a 5% interest rate environment will sell at face value so the bond will sell for $1,000. b) In a 10% rate environment, the bond will be worth 50/(1.10) +50/1.10^2 +1050/1.10^3= 875.65.

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