Question

Suppose you purchase a 10-year bond with 6.5 % annual coupons. You hold the bond for four years, and sell it immediately after receiving the fourth coupon. If the bond's yield to maturity was 4.5 % when you purchased and sold the bond, a. What cash flows will you pay and receive from your investment in the bond per $ 100 face value? b. What is the internal rate of return of your investment?

. The cash flows are as follows: (Round to the nearest cent.)

Year	0	1	2	3	4
Cash flow	$nothing	$nothing	$nothing	$nothing	$nothing

b. The internal rate of return of your investment is

nothing %.

(Enter your response as a percent rounded to one decimal place.)

Answer 1

a. Calculating price of bond in year 0

Coupon rate = 6.5%, Face value or par value = 100, Years to maturity = 10, Yield to maturity = 4.5%

Coupon = Coupon rate x face value = 6.5% x 100 = 6.50

To find the price of bond in year 0, we will use pv function in excel

Formula to be used in excel: =pv(rate,nper,-pmt,-pv)

Using pv function in excel, we get get price of bond in year 0 = 115.83

Hence, Purchase price of bond = 115.83

Calculating the price of bond at the end of year 4

After 4th coupon is received, then

Years left till maturity = 6, Coupon = 6.50, Face value = 100, Yield to maturity = 4.5%

To find selling price of bond at the end of year 4, we will use pv function in excel

Formula to be used in excel: =pv(rate,nper,-pmt,-pv)

Using pv function in excel, we get selling price of bond at end of year 4 or after receiving 4th coupon = 110.32

Cash flow in year 0 = - Purchase price of bond = - 115.83

Cash flow in year 1 = Cash flow in year 2 = Cash flow in year 3 = Coupon = 6.50

Cash flow in year 4 = Selling price of bond + Coupon = 110.32 + 6.50 = 116.82

Cash flow rounded to nearest cents are as follows

Year	0	1	2	3	4
Cash flow	-115.83	6.50	6.50	6.50	116.82

b. To find irr of the investment, we will use IRR function in excel

Formula to be used in excel: =IRR(Cash flows)

Using IRR function in excel, we IRR of investment = 4.5%