Treasury bills have a fixed face value (say $1000) and pay interest by selling at a discount. For example, if a one-year bill with a $1,000 face value sells today for $950, it will pay $1000-$950= $50 interest over its life. The interest rate on the bill is therefore $50/$950= 0.0526, or 5.26%.
Generalize this example. Let P be the price of the bill and R be the interest rate. Develop an algebraic formula expressing R in terms of P. (Hint: the interest earned is $1000 â P. What is the percentage interest rate?) Show that this formula illustrates the point made in the text: Higher bond prices means lower interest rates.