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Ec 565

Fall 2022

ASSIGNMENT 7

(due Tuesday, November 15, noon)

1. Exercise

Assume here is a government (e.g. England) that has a public debt in annuities at 3% and 4%.

1. Assume that the 3% annuities are perpetual with a price of 90. What is the long-term interest rate?

2. Assume that the 3% is perpetual and that the 4% is redeemable at par. The price of the 3% is 100 and it is expected to stay at that level. The government announces that it will redeem all the 4%, at par, 5 years from now. Determine the price of the 4% annuity just after the announcement. You will assume that people expect the policy of the government to be implemented for sure. (The redemption will  be financed by issuing annuities at 3%, but that financing is irrelevant for the answer to the question). You need a calculator or a spreadsheet program to answer the question. Explain carefully your computation.

2. Questions

1. Explain the difference between an interest reduction on redeemable debt and an interest reduction on non-redeemable debt.

2. Read these pages from the book by Dickson on the Financial Revolution in 18^th century England. Focus on pages 235 and 236. What is evaluation of Dickson about the success of the interest reduction? Read pages 573-375 in "Interest Reductions..." (and other material that you may need for an understanding).  Using the figure 5, discuss whether the market agreed with Dickson’s evaluation.