To further examine the relationship between interest rates and the price of financial assets, consider the effect of a change in an investors required return, or opportunity cost, on the price of a financial asset.

Five years ago, Alejandro purchased a perpetuity that agrees to pay him and his heirs $300 per month forever. At the time of purchase, Alejandro was expecting to earn an annual return of 7.00%, but in the intervening years, the economy and the available investment alternatives have changed. In todays market, it is now reasonable to anticipate an annual return of 4.25%.

By how much would you expect the value of Alejandros perpetuity to change from when he purchased it until today?

$51,429

$2,773

$84,706

$33,277

Interest rates affect corporate profits and security prices. Based on your understanding of the relationship between interest rates and corporate profits and security prices, identify which of the following statements is true and which is false. Ststements True False O A decrease in the interest rate paid by a business borrower will increase the likelihood that the firm will be able to repay its interest and principal on its debt securities or pay dividends on its equity securities. There is a positive, or direct, relationship between a firm's profits and the interest rate paid on the firm's debt securities. O When investors desire higher returns on their investment, they will decrease the price that they are willing to pay to acquire securities. Because the value of a security is a function of the security's expected future cash flows and the return required by investors, an increase in investors' returns will decrease the present value and market price of securities, all other considerations remaining O constant