Question

Consider a $6,000 8-yr coupon bond with a 3.5% coupon rate.

f.    After five years, the market interest rate has fallen to 2%. How much can this bond be sold for? (Answer in long form.)  

g.   Compute the original owner’s holding period return if the bond is originally purchased for $4,700. (3)

Answer 1

Annual coupon = $6,000 x 3.5% = $210

(f) After 5 years,

Years to maturity = 8 - 5 = 3

Bond price ($) = Present value of future coupon payments + Present value of redemption price (face value)

= 210 x P/A(2%, 3) + 6,000 x P/F(2%, 3)

= 210 x 2.8839** + 6,000 x 0.9423**

= 605.62 + 5,653.8

= 6,259.42

(g) If holding period return for 5 years be r%,

$4,700 x (1 + r)³ = $6,259.42

(1 + r)³ = $6,259.42 / $4,700 = 1.3318

Taking cube root,

1 + r = 1.1002

r = 0.1002

r = 10.02%

**From P/A and P/F Factor tables