Chapter 4: Q.13 (page 134)
Retired persons often have much of their wealth placed in savings accounts and other interest-bearing investments and complain whenever interest rates are low. Do they have a valid complaint?
Low nominal rates may have a negative impact on the wealth of senior adults and retirees.
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If the interest rate is 15%, what is the present value of a security that pays you \(1,100 next year, \)1,250 the year after, and $1,347 the year after that?
In this chapter, we discussed long-term bonds as if there were only one type, coupon bonds. In fact, investors can also purchase long-term discount bonds. A discount bond is sold at a low price, and the whole return comes in the form of a price appreciation. You can easily compute the current price of a discount bond by using the financial calculator at http://www .treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm.
To compute the values for savings bonds, read the instructions on the page and click on Get Started. Fill in the information (you do not need to fill in the Bond Serial Number field) and click on Calculate.
Which \(10,000 bond has the higher yield to maturity, a 20-year bond selling for \)8,000 with a current yield of 20% or a 1-year bond selling for $8,000 with a current yield of 10%?
Interest rates were lower in the mid-1980s than in the late 1970s, yet many economists have commented that real interest rates were actually much higher in the mid1980s than in the late 1970s. Does this make sense? Do you think that these economists are right?
The U.S. Treasury issues some bonds as Treasury Inflation Indexed Securities, or TIIS, which are bonds adjusted for inflation; hence the yields can be roughly interpreted as real interest rates. Go to the St. Louis Federal Reserve FRED database, and find data on the following TIIS bonds and their nominal counterparts. Then answer the questions below.
a. Following the Great Recession of 2008– 2009, the 5-, 7-, 10-, and even the 20-year TIIS yields became negative for a period of time. How is this possible?
b. Using the most recent data available, calculate the difference between the yields for each of the pairs of bonds (DGS5 – DFII5, etc.) listed above. What does this difference represent?
c. Based on your answer to part (b), are there significant variations among the differences in the bond-pair yields? Interpret the magnitude of the variation in differences among the pairs.
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