What is the price of a perpetuity that has a coupon of $50 per year and a yield to maturity of 2.5%? If the yield to maturity doubles, what will happen to its price?

1.

$2000

2.

If the yield to maturity doubles,the price of perpetuity would reduce by 100%

Explanation:

The price of the perpetuity is determined by dividing the coupon by the yield to maturity as shown below:

price=coupon/yield to maturity

coupon=$50

yield to maturity=2.5%

price=$50/2.5%

price=$2000

If the yield to maturity doubles, it becomes 5% and a new price is shown below:

price=$50/5%=$1000

He is aware that if interest rates increase, the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to less annual income from investments.

Frank is most concerned about protecting agains the "b. reinvestment rate risk" because it is the risk that interest rates will fall and therefore the investor must reinvest the cash flows of current assets at a lower rate than he did at the beginning. And as a consequence there is a decrease in income.

True or false: TRUE. Because Cash flows receivable in the short term are closer to being reinvested than cash flows receivable in the long term.