Question

. Suppose in 2020 you buy 2% coupon rate, $1000 face value bond for $1000 that has 3 years left till maturity. Suppose in 2021, when interest rates increase to 5%, you decide to sell it. a) Calculate the selling price of your bond in 2021. How did its value change because of the interest rate increase? What was your one-year rate of return?

Answer 1

Answer:
a)
value of the bond in the year 2021 is given by
=
= 944.22
Hence,
The selling price of the bond is 944.22. It has decreased because of increase in interest rate to 5% which started giving yield of $50 instead of $20 for $1000 bond. This has made the bond less attractive and hence lower bond price.

Coming to return of the bond calculation,
Coupon payment of the bond = 2% on $1000
= $20
Selling price of the bond = 944.22
Total income of the bond = 20 + 944.22
= $964.22

return from the bond = (964.22/1000) -1
= -3.58%

Hence, one year return from the bond = -3.58%

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