Question

1. A $1000 face value bond has a 10% coupon rate, its current price is $960, and its price is expected to increase to $980 next year.
2. Calculate the current yield, the expected rate capital gain, and the expected rate of return.

Answer 1

As, Coupon payment = (Coupon rate/100) * Face value = (10/100) * $1000 = 1000/10 = $100

Now we know, Current Yield = (Coupon Payment ÷ Current price ) * 100

= ($100 ÷ $960) * 100

= 0.1041666 * 100

= 10.4167%

Now, Expected rate of Capital Gain = {(Expected Price - Current Price)/Current Price} * 100

= {($980 - $960)/$960} * 100

= {$20/$960} * 100

= 0.0208333 * 100

= 2.0833%

Expected rate of Return = Current Yield + Expected rate of Capital Gain

= 10.4167% + 2.0833%

= 12.5%

So, We have calculated,

Current Yield = 10.4167%

Expected rate of capital gain = 2.0833%

Expected rate of return = 12.5%