Alexander Smith and Olivia Williams are vice presidents of Mutual of Seattle Group Health Cooperative and co-directors of the organization's pension fund management division. The unions that represent the GHC hospital staff have requested an investment seminar so that they better understand the decisions being made on behalf of their members. Alexander and Olivia, who will make the actual presentation, have asked you to help them by answering the following questions.
a. What is the value of a ten-year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent?
b. What would be the value of the bond described in question a. if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would we now have a discount or a premium bond?
c. What would be the value of the bond described in question a. if, just after it had been issued, the expected inflation rate fell by 3 percentage points, causing investors to require a 7 percent return? Would we now have a discount or a premium bond?
d. What would happen to the value of the ten-year bond over time if the required rate of return remained at 13 percent, remained at 7 percent, or remained at 10 percent?