Question

A government bond matures in 8 years, makes annual coupon payments of 5.2% and offers a yield of 3.2% annually compounded. Assume face value is $1,000. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

a. Suppose that one year later the bond still yields 3.2%. What return has the bondholder earned over the 12-month period?

b. Now suppose that the bond yields 2.2% at the end of the year. What return did the bondholder earn in this case?

Answer 1

Answer a)

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 0.032

And n is the no of Compounding periods 8 years

Coupon 0.052

=

= 1139.22

Value of Bond after a year

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 0.032

And n is the no of Compounding periods 7 years

Coupon 0.052

=

= 1123.67

Return % = Coupon + Capital Gain / Purchase Price

= 52 + (1123.67 - 1139.22) / 1139.22

= 3.20%  

Answer b)

Value of Bond after a year

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 0.022

And n is the no of Compounding periods 7 years

Coupon 0.052

=

= 1192.68

Return % = Coupon + Capital Gain / Purchase Price

= 52 + (1192.68 - 1139.22) / 1139.22

= 9.26%