Question

Suppose that an investor with a five-year investment horizon is considering purchasing a seven-year 9% coupon bond selling at par (semi-annual coupon payments). The investor expects that he can reinvest the coupon payments at an annual interest rate of 9.4% and that at the end of the investment horizon two-year bonds will be selling to offer a yield to maturity of 11.2%.

What is the total of coupon and coupon reinvestment?  (Round your answer to 2 decimal points)

What is the sale price of the bond at the end of the holding period?  (Round your answer to 2 decimal points)

What is the expected (holding period) return for this bond?  (Enter the result in percentage points (10 if you find 10%), round your answer to 2 decimal points)

Answer 1

Let par value of Bond = $1000

Since Bond pays semi-annual coupon, coupon payment = (9%/2)*$1000

= $45

Semiannual reinvestment rate = 9.4%/2

= 4.7%

Expected holding period return

Total proceeds at the end of holding period = Coupon and coupon reinvestment + Bond price

= $558.14+$961.53

= $ 1519.67

$1000 = $1519.67/(1+r)⁵

(1+r)⁵ = $1519.67/$1000

1+r = $1.51967^(1/5)

r = 1.0873-1

r = 8.73%

Therefore, expected holding period return = 8.73%