Question

Suppose there is a 3-year bond with a $1000 face value, 12% coupon payments and a 6% yield to maturity.

a) Without any calculation, briefly explain whether this bond will be selling a premium or a discount.

b) Calculate the price of this bond.

c) Calculate the duration of this bond.

d) If someone buys this bond and holds it for three years, what is their rate of return?

e) Suppose after one year, interest rates in the economy fall by 2%. If the person that bought this bond sells it at that time, what would be their rate of return? (Hint: First think about what the fall in interest rates will do to the bond’s price and then think about the rate of return.)

Answer 1

a)

Yield to maturity and bond price has inverse relationship. If yield increase price will decrease and vice-versa. So bond will trade at premium.

b)

c)

d)

Their rate of return will equal to yield to maturity.

e)