Question

In: Finance

Consider a bond paying a coupon rate of 20% per year, compounded annually, when the market interest rate (YTM) is only 10% per year.

Consider a bond paying a coupon rate of 20% per year, compounded annually, when the market interest rate (YTM) is only 10% per year. The market interest rate (return for an investment of like risk) will remain at 10% for the next two years. The bond has two years until maturity. What is the HOLDING PERIOD RETURN (or rate of return) over the first year on this bond?


a. 8.32% b. 27.58% c. 9.24% d. 20% e. 10%

Solutions

Expert Solution

Price of a bond is the present value of its cash flows. The cash flows are the coupon payments and the face value receivable on maturity

Price of bond is calculated using PV function in Excel :

rate = YTM of bond = market interest rate

nper = Years remaining until maturity

pmt = annual coupon payment = face value * coupon rate

fv = face value receivable on maturity

Let us assume the face value of the bond is $1,000.

Price of the bond today, and after 1 year is calculated as below :

HPR = (price after 1 year - price today + annual coupon payment) / price today

HPR = ($1,090.91 - $1,173.55 + $200) / $1,173.55

HPR = 10.00%

The answer is (e)

jeff jeffy answered 2 years ago
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