A bond with no expiration has an original price of $10,000 and a fixed annual interest payment of $1000.If the price of this bond decreases by $2000, the interest rate in effect will:
A)decrease by 1.5 percentage points.
B)decrease by 2.5 percentage points.
C)increase by 1.5 percentage points.
D)increase by 2.5 percentage points.

Question

Quizplus · Accepted Answer

The interest rate in effect is the fixed annual interest payment divided by the original price:

$1000 / $10,000 = 0.1 or 10%

If the price of the bond decreases by $2000, then the new price is:

$10,000 - $2000 = $8000

To keep the same interest rate in effect, the annual interest payment must remain at $1000.

Therefore, the new interest rate in effect is:

$1000 / $8000 = 0.125 or 12.5%

The difference between the old interest rate and the new interest rate is:

10% - 12.5% = -2.5%

Therefore, the interest rate in effect has increased by 2.5 percentage points.

The correct answer is D.

A Bond with No Expiration Has an Original Price of $10,000