Your company is interested in analyzing the behaviour of interest rates and the models used to predict interest rates in the future. As an initial project in this area, you have been assigned the task of creating a presentation that will show the top management team assigned this project the basics of what affects interest rates and how equilibrium prices change over time. The better your presentation to this group, the more likely you are to become a voting member of the team. To begin your work, you have decided to identify a series of questions that you think this team will ask, including tables and graphs that will satisfy their concerns about the final presentation to the CFO. You decide to start by answering the following questions, assuming that the face value of a discount bond is $1000 and the time to maturity is one year.
1. What is the expected return for this bond if the market price is
a. $800?
b. $950?
c. $1000
2. If the market-clearing price (market equilibrium) of this bond has a return of 20% what is the market price where the quantity demanded equals the quantity supplied? (Hint: Use the same expected return equation, solve for P.)
3. Discuss some factors that would cause the demand and supply curve for bonds to shift? Illustrate your answer with diagrams.