You are purchasing a consul (a bond that has no maturity date, thus never matures or expires). This consul promises annual coupon payments of $4 into perpetuity.
A. If the current interest rate is 5%, what is the price of the consul? (Hint: See the Chapter 3 PPT and Study Guide chapter for help here!)
B. You are concerned that the interest rate may rise to 6%. Which changes by a larger percentage, the consul’s price or the interest rate?
C. If you hold the consul for one year and sell it next year when the interest rate actually does rise to 6%, what rate of return did you earn? Why?