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) rises from 8 percent to 10 percent.
C) does not change because it is not affected by the price of the bond.
D) falls from 10 percent to 6 percent.

Question

Quizplus · Accepted Answer

The interest rate (yield) of a bond is calculated as the annual payment divided by the price of the bond. Initially, with a $100 payment and a $1,000 price, the interest rate is 10% ($100/$1,000). When the price increases to $1,250, the new interest rate is 8% ($100/$1,250), indicating a fall in the interest rate.

Suppose That a Bond Promises to Pay Its Holder $100