Suppose that a bond promises to pay its holder $100 a year forever. If the price of the bond increases from $1,000 to $1,250, then the interest rate on the bond
A) falls from 10 percent to 8 percent.
B) falls from 10 percent to 6 percent.
C) rises from 8 percent to 10 percent.
D) does not change because it is not affected by the price of the bond.

Question

Quizplus · Accepted Answer

The interest rate (yield) is calculated as the annual payment divided by the bond price. Initially, it is $100/$1,000 = 10%. After the price increase, it is $100/$1,250 = 8%.

Suppose That a Bond Promises to Pay Its Holder $100