If the nominal rate of interest is 3% and the real of interest is just 1.3%, wha
ID: 2759553 • Letter: I
Question
If the nominal rate of interest is 3% and the real of interest is just 1.3%, what is the expected inflation rate according to the Fisher Effect? Buy High and Sell Higher Corp. has a 6% coupon rate on bond with a par value of $1,000, paid annually. The YTM (yield to maturity) is 7% and the current yield on the bond is 6 55% Find the current price of the bond based on information on this current yield. A graph of the yield relative to the length of maturity is called the term structure of interest rates. Which of the following (by selecting a letter attached to it) is an illustration of a "normal" yield curve?Explanation / Answer
(6) According to Fisher Effect,
(1+ inflation rate) = (1+Nominal rate) / (1+real rate)
(1 + inflation rate) = 1.03 / 1.013 = 1.017
Inflation rate = 1.017 - 1 = 0.017*100 = 1.7%
(a) Inflation is about 1.7%
(7) Current price of bond = Annual Interest / Current yield
Current price of bond = (1,000 x 6%) / 0.0655 = 60 / 0.0655 = $ 916.03
Answer: (a) $ 916.03
(8) Answer: (b)
Note: The term structure of interest is also called yield curve.A normal yield curve is when the curve slope is upwards.