Question

Question 1::

Consider a corporate bond with the face value of $1,000, the coupon rate of 8% per annum, paying coupons semi-annually and the remaining term to maturity of 6 years. The current required yield-to-maturity of this bond is 6% per annum. Suppose an investor buys one bond and holds it for two years. At the end of year 2, required yield-to-maturity is expected to rise from 6% to 8% per annum. Find the investor's annual rate of return over his/her 2-year holding period.

Answer 1

semiannual months after 2 years : 6-2 =4 years or 4*2 = 8

semiannual yield : 8*6/12 =4%

semiannual interest : 1000*.08*6/12 = 40

Price of bond at end of year2 :[PVA 4%,8*Interest ]+[PVF 4%,8*Face value]

          = [6.73274*40]+[ .73069*1000]

           = 269.31+ 730.69

           = 1000

**PUrchase price :

Semiannual months : 6*2=12

semiannual yield : 6*6/12 =3%

Price : [PVA3%,12*Interest]+[PVF 3%,12*face value]

      =[9.95400*40]+[.70138*1000]

       = 398.16+ 703.18

        = 1101.34

Annual rate of return : [price at end of year 2 -purchase price +interest over 2 years] /purycase price

          =[1000-1101.34+ 160]/1101.34

          = 58.66/1101.34

            = .0533 or 5.33% for 2 years

annual return : 5.33/2 = 2.67% annually

**interest for 2 years : 40 *4 semiannual months = 160