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27 February, 17:41

The price of a bond is equal to the sum of the present values of its future payments. Suppose a certain bond pays $50 one year from today and $1,050 two years from today. What is the price of the bond if the interest rate is 5 percent

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  1. 27 February, 21:01
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    The correct answer is $1,000.

    Explanation:

    According to the scenario, the given data are as follows:

    For one year

    Bond pay (p) = $50

    Time period (t) = 1 year

    Interest rate (r) = 5%.

    So, Price of bond for 1st year = p (1 + r) ^-t

    By putting the value, we get

    Price of bond for 1st year = $50 (1 + 0.05) ^-1 = $47.62

    For Second year

    Bond pay (p) = $1,050

    Time period (t) = 2 year

    Interest rate (r) = 5%.

    So, Price of bond for 2nd year = p (1 + r) ^-t

    By putting the value, we get

    Price of bond for 2nd year = $1,050 (1 + 0.05) ^-2 = $952.38

    So, Total price of the bond = Price of bond for 1st year + Price of bond for 2nd year

    = $47.62 + $952.38

    = $1,000
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