Problem Set 4: The money market model and non-traditional monetary policy

Question 1: Bond prices and interest rates (10 points)
Consider a bond that promises to pay $100 in one year.
a. What is the equilibrium interest rate on the bond if its price today is $85? $95?
b. Explain why there is an inverse relationship between bond prices and interest rates.
(Explain the economic logic, not only the mechanics of the formula).
c. If the interest rate is 4%, what is the price of the bond today?

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