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7 August, 21:35

Suppose Baa-rated bonds currently yield 6%, while Aa-rated bonds yield 4%. Now suppose that due to an increase in the expected inflation rate, the yields on both bonds increase by 1%. What would happen to the confidence index? (Round your answers to 4 decimal places.)

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  1. 8 August, 01:04
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    Initial confidence index 66.67%

    New confidence index 71.4%

    Explanation:

    Calculation of what would happen to the

    confidence index

    Using this formula

    Confidence index = (Average yield for high grate bonds) / (Average yield for intermediate graded bonds)

    Let plug in the formula

    Initial confidence index=4%/6%

    =0.6667 * 100

    =66.67%

    Due to increase in the yields the New Confidence Index will be;

    New confidence index

    = (4%+1%) / (6%+1%)

    =5%/7%=0.7142857 or 0.714

    0.714*100=71.4%

    Hence, the New Confidence index tend to indicates slightly higher confidence and the reason for the increase in the index is the expectation of higher inflation.
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