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 that has 16 years to maturity, an annual coupon rate of 8 percent, par value of $1,000, and price of $1,170. What rate of return do you expect to earn on your investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b-1.	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.)
b-2.	What is the HPY on your investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

  

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Answe a)

Current Price = 1170

Coupon 8%

Maturity = 16 years

SInce the Current Price of Bond > Par Value, the TYM will be less than Coupon.

Let's assume the YTM be 6%

Value of Bond =

=

= 1202.12

Now,

Let's assume the YTM be 7%

Value of Bond =

=

= 1094.47

Using interpolation

YTM =

= 6% + ((1202.12 - 1170) / (1202.12 - 1170) + (1170 - 1094.47)) * (7-6)

= 6% + 0.28%

= 6.28%

Answer b)

After 2 years

Value of Bond =

r = 6.28% - 1% = 5.28%

n = 16 - 2 = 14 years

=

= 1264.49

Answer c)

HPY = Coupons + Capital Gain

= (80 * 2) + (1264.49 - 1170)

= 254.49