The interest rate is 10% and there is no inflation.A bond is available that can be redeemed either after one year or after two years.If it is redeemed after one year, the investor gets $110.If it is redeemed after two years, the investor gets $117.70.The investor gets no other payments than what she receives when she redeems the bond.In equilibrium, investors will be willing to pay more than $100 for this bond.

Question

Quizplus · Accepted Answer

Given the interest rate of 10% and no inflation, the present value of the bond's future payments should equal its face value for it to be a fair investment. For a $100 investment, receiving $110 after one year is exactly a 10% return, matching the interest rate. For the two-year option, a 10% annual interest rate compounded would result in a future value of $121 ($100 * 1.1 * 1.1), not $117.70. Therefore, in equilibrium, investors would not be willing to pay more than $100 for this bond, as its future payments do not exceed the returns of an alternative investment with a 10% interest rate.

The Interest Rate Is 10% and There Is No Inflation