Question

The YTM on a bond is the interest rate you earn on your investment if interest rates don’t change. If you actually sell the bond before it matures, your realized return is known as the holding period yield (HPY).

a.

Suppose that today you buy a bond with an annual coupon of 10 percent for $1,120. The bond has 17 years to maturity. What rate of return do you expect to earn on your investment? Assume a par value of $1,000. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Expected rate of return

%

b1.	Two years from now, the YTM on your bond has declined by 1 percent, and you decide to sell. What price will your bond sell for? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Bond price

$

b2.	What is the HPY on your investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

HPY

%

Answer 1

a. To calculate return on investment, we need to calculate YTM.

GIven that price=$1,120, years to maturity=17 and coupon=10% annually whose par value is $1,000.

So, interest=1,000*10%=$100.

Thus,

  

  

  

   that is 8.77%

b1. YTM after two years=8.77-1=7.77%

So, current price of bond=Coupon*PVAF(YTM,n)+Redemption*PVIF(YTM,n)

=100*PVAF(7.77%,15)+1,000*PVIF(7,77%,15)

=100*8.7185+1,000*0.3287

=871.85+328.7

=$1,200.55

b2. We can again use the YTM formula to calculate the Holding Period Yield(HPY) as follows:

  

  

  

   or 12.09%