Question

Use the bond term's below to answer the question
Maturity 5 years
Coupon Rate 3%
Face value $1,000
Annual Coupons
Market Interest Rate 6%

Assuming the market interest rate remains constant throughout the bond's life, what is percentage capital gains/loss between periods 0 and 1 ?

2.69%

2.47%

2.64%

2.57%

If the market interest rate stays constant, the one period Current Yield and the one period Capital Gains/Loss on the bond add-up to the bond’s _____________

coupon rate

current price

par value

total return

Answer 1

Bond Valuation: The value of bond is the present value of the expected cashflows from the bond,discounted at Yield to Maturity(YTM).

Prima facie, the bond will trade at discount as YTM>coupon rate

Year	Cash flow	PVAF/PVF@6%	Present Value (Cashflow*PVAF/PVF)
1-5	30	4.2124	126.37
5	1000	0.7473	747.26

Current Market Price of Bonds P0 = Cashflow*PVAF/PVF

= 126.37+747.26

= 873.63

Year	Cash flow	PVAF/PVF@6%	Present Value (Cashflow*PVAF/PVF)
1-4	30	3.4651	103.95
4	1000	0.7921	792.09

Market Price of Bonds in year 1 P1 = Cashflow*PVAF/PVF

= 103.95+792.09

= 896.05

Capital Gain Yield = (P1-P0)/P0

= (896.05-873.63)/873.63

= 22.42/873.63

= 2.57%

Investor's total return comprises of 2 elements-capital gain/loss (change in market price) and coupon payment.

Total Return = Current yield + Capital Gain/Loss Yield