NewsWire--JANUARY 19, 1998
TOPIC:
Interest Rates, Business Decisions, and Bond Valuation
SOURCE:
"The Zero Inflation Economy," Business Week,
January 19,1998, pages 28-31.
SYNOPSIS:
One of the major determinants of nominal interest rates is the
expected rate of inflation. This article documents the extremely
low inflation rate we are currently experiencing in the U.S. economy
and explains its impact on corporate sales and profits. It also
describes the potential for international competitors to become
more competitive, especially for commodity producers. A related
article, "Wall Street: No More Easy Street," (page
32) provides more insight into which industries stand to gain
or lose in a zero inflation environment.
DISCUSSION QUESTIONS:
1. In July 1996, long-term
U.S. Government bonds were priced to yield an interest rate of
7.1%. According to the article, how has this rate changed? Use
Equation 4-1 on page 127 to articulate the reasons for these changes.
2. According to the article,
why is low inflation good news for some firms, but bad for others?
How does the strong (zero inflation) dollar influence international
competition?
3. Suppose the U.S. Government
issued two bonds last year. Both sold at a price equal to its
par value of $1,000. Bond A was a 30-year bond paying a 7.1%
annual coupon. Bond B was a 10-year bond also paying a 7.1% annual
coupon. Now both bonds are priced to yield 5.8%. Determine the
current price for each bond. Which bond appears to have more
interest rate risk?
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