Question

1. Suppose that you own a $1,000-face-value coupon bond which had a 10% coupon rate and 10 years to maturity. Moreover, its current price is $1,000.

A.What is the yield to maturity?

B.Now suppose that the investors expect the interest rate will rise to 13% in next year. What will be the bond price next year?

C.Calculate thecurrent yield,the expected rateof capital gain(2pts),and the expected rate of return if you have to sell this bond next year.

Answer 1

Answer(a): YTM = [C + (F-P) / n] / (F+P) / 2

Given: C = 1000*10% = $100, F = $1000, P = $1000, n=10 years

Putting all the values in the formula, we get:

YTM = 10%

Answer(b): When interest rate =13%, Bond price:

Bond price = C * [[(1-(1/(1+r)ⁿ] / r ]+ F / (1+r)ⁿ

Given: C = $100, r = 13%, F = $1000, n = 10 years

Putting these values in the formula, we get:

Bond price = $837.21

Answer(c): Current Yield = Annual coupon / Bond price

Current Yield: 100/837.21 = 11.94%