You’ve just purchased……

Question

8. You’ve just purchased a Government Infrastructure Bond from the Principality of Monaco. The bond is designed to pay you 75 euros worth of interest forever. In today’s euros, how much is that bond worth, if you assume the relevant long term interest rate if 5%?

Answer 1

Since you get paid €75 forever, this steam of cash inflows can be valued like a perpetuity. The formula for valuing a perpetuity is: PV_Perpetuity = Cash Flow / Interest Rate.

We are given the cash flow, €75, and the interest rate, 5%. Filling the values into the formula, we get: PV_Perpetuity = €75 / 0.05 = €1,500.

The bond is therefore €1,500 today.