Question

Bond A is a 10% coupon bond with a face value of $1,000 and a maturity of 3 years. The discount rate (required return, or interest rate) is 8% now or in the future.

A. What is the bond price now, in year 1, in year 2, and in year 3

     (P0,P1,P2 and P3)?

B. If you buy the bond now and hold it for one year, what is the

     (expected) rate of return?

C. If you buy the bond at year 1 and hold it for one year, what is

    the (expected) rate of return?

D. If you buy the bond now and hold it until its maturity, what is

    the (expected) rate of return?

Answer 1

A.

P0

Year	Cash Flow	PVF @ 8%	Present Value
1	100	0.926	92.6
2	100	0.857	85.7
3	100	0.794	79.35185185
3	1000	0.794	794
Value of Bond	1051.651852

P1

Year	Cash Flow	PVF @ 8%	Present Value
1	0	0.000	0
2	100	0.926	92.6
3	100	0.857	85.74074074
3	1000	0.857	857
Value of Bond	1035.340741

P2

Year	Cash Flow	PVF @ 8%	Present Value
1	0	0.000	0
2	0	0.000	0
3	100	0.926	92.6
3	1000	0.926	926
Value of Bond	1018.6

P3.

After 3 years bond will get paid and hence par value of bond or you can say that after 3 years bond will be repaid at $1000

B.

Expected rate of Return = 8% (Approx.)

C.

Expected rate of Return = 8% (Approx.)

D.

Expected rate of Return = 23.70% or 24% (Approx.) for 3 years