The price of a bond is equal to the sum of the present values of its future payments. Suppose a certain bond pays $50 one year from today and $1,050 two years from today. What is the price of the bond if the interest rate is 5 percent

The correct answer is $1,000.

Explanation:

According to the scenario, the given data are as follows:

For one year

Bond pay (p) = $50

Time period (t) = 1 year

Interest rate (r) = 5%.

So, Price of bond for 1st year = p (1 + r) ^-t

By putting the value, we get

Price of bond for 1st year = $50 (1 + 0.05) ^-1 = $47.62

For Second year

Bond pay (p) = $1,050

Time period (t) = 2 year

Interest rate (r) = 5%.

So, Price of bond for 2nd year = p (1 + r) ^-t

By putting the value, we get

Price of bond for 2nd year = $1,050 (1 + 0.05) ^-2 = $952.38

So, Total price of the bond = Price of bond for 1st year + Price of bond for 2nd year

= $47.62 + $952.38

= $1,000