Question

5. There is a 12-year bond with a par of $1,000 and a coupon of 6.22%. Suppose the bond is bought today at a price of $1,032.60, and the market interest rate is 5.82%.

It turns out that in 3 years an investor sells the bond at a price of $1,019.12. Calculate the annual realized return over the 3 years the investor held the bond.  Show your work and explain.

Answer 1

		5.00%						6.00%
Year	Cash Flow	PV factor = 1/ (1+r)^t	PV					PV factor = 1/ (1+r)^t	PV
0	$               (1,032.60)	1.000	$(1,032.60)					1.000	$(1,032.60)
1	$                      58.20	0.952	$       55.43					0.943	$       54.91
2	$                      58.20	0.907	$       52.79					0.890	$       51.80
3	$                      58.20	0.864	$       50.28					0.840	$       48.87
3	$                 1,019.12	0.864	$     880.35					0.840	$     855.67
		Total	$         6.25					Total	$     (21.36)
NPV @ 0.05	6.25
NPV @ 0.06	(21.36)
Difference in both	27.61
Annualized return	=Lower rate + Difference in rates*(NPV at lower rate)/(Lower rate NPV-Higher rate NPV)
	'=5%+ (6%-5%)*(6.2472/(6.2472+21.357)
Annualized return	5.22%