2. [Financial and Capital Markets Markets for Financial Capital]

Suppose the U.S. government issues a one-year bond with a face value of $2,000 and a zero coupon.

1. If interest rates on bank deposits are 5%, would we expect the yield of the bond to be greater than, less than, or equal to 5%? Explain intuitively why this is the case.

2. What will the market price of the bond be, given the yield?

3. Suppose the bond is sold for the price you calculated in part (b). One day later, interest rates on bank deposits suddenly decrease from 5% to 4%. What would the bonds yield adjust to? Calculate the new price of the bond, given this yield. Does the price of the bond increase or decrease? Explain intuitively why this is the case.