Suppose you paid $1,000 for a perpetuity bond that pays $40 a year. suppose the interest rate drop fall to 1%. what would be the price of the bond if it continues to pay $40 per year?

PV=1,333

Explanation:

the key to answer this question is to remember the formula for calculating a perpetuity:

where PV is the present value, C is the regular payment and i is the interest rate charged, so in the initial case we have:

solving i we have:

i=40/1,000

i=0.04

so if the i rate falls 1 % the price of the bond will be

it could sound rare that if the rate falls the present value increases but keep in mind that the more rate the less price is a relation between rates and bonds prices

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