Suppose Baa-rated bonds currently yield 6%, while Aa-rated bonds yield 4%. Now suppose that due to an increase in the expected inflation rate, the yields on both bonds increase by 1%. What would happen to the confidence index? (Round your answers to 4 decimal places.)

Initial confidence index 66.67%

New confidence index 71.4%

Explanation:

Calculation of what would happen to the

confidence index

Using this formula

Confidence index = (Average yield for high grate bonds) / (Average yield for intermediate graded bonds)

Let plug in the formula

Initial confidence index=4%/6%

=0.6667 * 100

=66.67%

Due to increase in the yields the New Confidence Index will be;

New confidence index

= (4%+1%) / (6%+1%)

=5%/7%=0.7142857 or 0.714

0.714*100=71.4%

Hence, the New Confidence index tend to indicates slightly higher confidence and the reason for the increase in the index is the expectation of higher inflation.