You are considering purchasing a consol that promises annual payments of $4. a.

Question

You are considering purchasing a consol that promises annual payments of $4. a. If the current interest rate is 3.5 percent, what is the price of the consol? Instructions: Enter your response to the nearest penny (two decimal places) The price of the consol Is $ b. You are concerned that the interest rate may rise to 6 percent. Compute the percentage change in the price of the consol and the percentage change in the interest rate. Compare them. Instructions: Enter your response for dollar amounts rounded to the nearest penny (two decimal places) and responses for percentages rounded to the nearest tenth (one decimal place). The new price of the consol would be $ The price of the consol falls by % and the interest rises by 1% c. Your investment horlzon is one year. You purchase the consol when the interest rate is 3.5 percent and sell it a year later, following a rise in the interest rate to 6 percent. What is your holding period return? Instructions: Enter your response rounded to the nearest tenth (one decimal place). Your holding period return is %

Explanation / Answer

Answer a.

Annual payment = $4
Interest rate = 3.50%

Price of Consol = Annual payment / Interest rate
Price of Consol = $4 / 0.035
Price of Consol = $114.29

Answer b.

Annual payment = $4
Interest rate = 6.00%

Price of Consol = Annual payment / Interest rate
Price of Consol = $4 / 0.06
Price of Consol = $66.67

Change in Price = ($66.67 - $114.29) / $114.29
Change in Price = -41.67%

Change in Interest Rate = (0.06 - 0.035) / 0.035
Change in Interest Rate = 71.43%

The price of the consol falls by 41.67% and the interest rises by 71.43%

Answer c.

Holding Period Return = (Selling Price + Payment - Purchase Price) / Purchase Price
Holding Period Return = ($66.67 + $4 - $114.29) / $114.29
Holding Period Return = -38.17%

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