Question

A man buys a corporate bond from a bond brokerage house for $925. The bond has a face value of $1,000 and a 4% coupon rate paid semiannually. If the bond will be paid off at the end of the 10 years, what rate of return will the man receive?

Can you please solve this using the compounding interest factors found in the tables?

Answer 1

Ans. Price of the bond, P = $925

Face Value, F = $1000

Coupon rate, c = 4%

Coupon, C = c*F/2 = 0.04*1000/2 = $40/2 = $20 per 6 months

Time to maturity, T = 10 years = 2*10 = 20 periods

The rate of return (r) on the bond is the interest rate at which the present value of the coupon payments and face value is equal to the price of the bond.

=> P = C*(P/A, r%, 20) + F*(P/F, r%, 20)

=> 925 = 20*[1-1/(1+r)^20]/r + 1000/(1+r)^20

=> r = 0.0248 or 2.48% (this is semi annual yield to maturity)

Annual Yield to maturity = 2.48*2 = 4.96%