Question

A bond was purchased at a premium and is now selling at a discount because of a change in market interest rates. If the bond pays a 4% annual coupon, what is the likely impact on the holding-period return if an investor decides to sell now?

Answer 1

Ans

Before Answering this Question, Let us Understand the Relationship between following with Example:

• Pricing of Bond ,
• Coupon Rate &
• Market Interest Rate (ie. YTM or Our Expectation)

COUPON RATE	YTM / MARKET RATE	PRICE OF BOND	REASON
4%	3%	AT PREMIUM	The Reason is that We are getting a Return (ie. Coupon) More than our Expectation (ie YTM). Hence people will rush to Buy such Bond Increasing the Price.
4%	5%	AT DISCOUNT	The Reason is that We are getting a Return (ie. Coupon) Less than our Expectation (ie YTM). Hence people will rush to Sell such Bond Decreasing the Price.
4%	4%	AT PAR	The Reason is that We are getting a Return (ie. Coupon) Equals to our Expectation (ie YTM). Hence people will Hold such Bond

Now,

• We Purchased a Bond at Premium (we have understood why so in above relationship) &
• Selling at Discount
• HOLDING PERIOD RETURN = INTEREST YIELD + CAPITAL YIELD

Our Holding Period Return Will get Decreased due to Capital Loss that we have incurred by doing so.

HOPE YOU ARE CLEAR WITH THE ANS & CONCEPT. STILL U CAN ASK ANY DOUBT IN COMMENT :)