Question

An investor is interested in purchasing a 30-year U.S. government bond carrying an 8 percent coupon rate. The bond’s current market price is $935 for a $1000 par value instrument. Suppose the investor sells the bond at the end of 13 years for $970. What is the holding-period yield? What is the effective yield?

Answer 1

Compute the total interest paid, using the equation as shown below:

Interest = Par Value*Interest rate*Holding period

             = $1,000*8%*13 years

             = $1,040

Hence, the total interest is $1,040

Compute the holding period return (HPR), using the equation as shown below:

HPR = (Selling price + Interest – Purchase price)/ Purchase price

         = ($970 + $1,040 - $935)/ $935

         = 114.973262032%

Hence, HPR is 114.973262032%.

Compute the effective yield, using the equation as shown below:

Yield to maturity = [Interest + {(Maturity value – Redemption value)/ Number of periods}]/ {(Maturity value + Redemption value)/2}

      = [($1,000*8%) + {($970 – $935)/ 13 years}]/ {($970 + $935)/2}

      = ($80 + $2.6923076923)/ $952.50

      = 8.681607106%

Hence, the effective yield is 8.681607106%.