Expert: Doug Ingram - 10/15/2002

Question
Suppose I buy a bond for $1,000 from the federal government, which guarantees that the owner will receive $80 a year forever (8 percent was the market rate of interest when you bought the bond).  Suppose that, immediately after buying it, the market rate of interest raises to 10 percent.  What if the new market value of my bond?  

Answer
Without a maturity, you can't say.

You bond is worth the present value of a series of $20 LESS per year times the number of years you would hold it.

If one year:
PV =  1080/(1.10)^1    =981.82

If 2 years:
PV = 80/(1.1)^1 +1080/(1.1)^2  = 965.29

If 3 years:
PV=  80/(1.1)^1 + 80/(1.1)^2 + 1080/(1.1)^3 = 950.26

(just under the $20/year difference)

If X years:

PV = 80/(1.1)^1 + 80/(1.1)^2 + ........ + 1080/(1.1)^x