Question
In: Accounting
In early January 2014, you purchased $83,000 worth of some high-grade corporate bonds. The bonds carried...
In early January 2014, you purchased $83,000 worth of some high-grade corporate bonds. The bonds carried a coupon of 7% and mature in 2027. You paid 101.477 when you bought the bonds. Over the five years from 2014 through 2018, the bonds were priced in the market as follows:
Quoted Prices (% of $1,000 par value)
Year Beginning of the Year End of the
Year Average Holding Period Return on High-Grade
Corporate Bonds
2014 101.477 110.926 -8.90%
2015 110.926 108.012 10.80%
2016 108.012 106.104 1.30%
2017 106.104 106.969 0.70%
2018 106.969 102.035 2.90%
. Annual coupon payments were made on schedule throughout the five-year period.
a. Find the annual holding period returns for 2014 through 2018.
(See Chapter 5 for the HPR formula.)
b. Use the average return information in the given table to evaluate the investment performance of this bond. How do you think it stacks up against the market? Explain.
Solutions
Expert Solution
| Bond par value | 1000 |
| Coupon | 7% |
A. Computation of Holding Period Return (HPR)
| HPR Formula = p1-p0/p0 + I/p0 |
| Year | Beginning %of Year | End % of year | Beginning price(p0) | End Price( P1) | Average Return | Coupon payments(I) | HPR |
| 2014 | 101.477 | 110.926 | 1014.77 | 1109.26 | -8.90% | 70 | 16% |
| 2015 | 110.926 | 108.012 | 1109.26 | 1080.12 | 10.80% | 70 | 4% |
| 2016 | 108.012 | 106.104 | 1080.12 | 1061.04 | 1.30% | 70 | 5% |
| 2017 | 106.104 | 106.969 | 1061.04 | 1069.69 | 0.70% | 70 | 7% |
| 2018 | 106.969 | 102.035 | 1069.69 | 1020.35 | 2.90% | 70 | 2% |
B.Evaluation of Investment Performance of this bond
As we know,The higher a bond's price, the lower its yield. That's because an investor buying the bond has to pay more for the same return.
| Year | Beginning price(p0) | End Price( P1) | Average Return | Bond price scenario(Is P1>P0) | Remarks |
| 2014 | 1014.77 | 1109.26 | -8.90% | Yes | As P1 is Greater than P0,due to this Average return is lower and becomes negative in this case,because Higher bond price,lower the YTM |
| 2015 | 1109.26 | 1080.12 | 10.80% | No | As P1 is Smaller than P0,due to this Average return is Higher ,because Lower the bond price,Higher the YTM |
| 2016 | 1080.12 | 1061.04 | 1.30% | No | As P1 is Smaller than P0,due to this Average return is Higher ,because Lower the bond price,Higher the YTM |
| 2017 | 1061.04 | 1069.69 | 0.70% | Yes | As P1 is Greater than P0,due to this Average return is lower,because Higher bond price,lower the YTM |
| 2018 | 1069.69 | 1020.35 | 2.90% | No | As P1 is Smaller than P0,due to this Average return is Higher ,because Lower the bond price,Higher the YTM |
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