Question

A bond with a face value of $1,000 has 10 years until maturity, carries a coupon rate of 7.9%, and sells for $1,110. Interest is paid annually.

a. If the bond has a yield to maturity of 10.1% 1 year from now, what will its price be at that time? (Do not round intermediate calculations. Round your anser to nearest whole number.)

b. What will be the annual rate of return on the bond? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places. Negative amount should be indicated by a minus sign.)

c. Now assume that interest is paid semiannually. What will be the annual rate of return on the bond?

Slightly greater than your part b answer

Slightly less than your part b answer

d. If the inflation rate during the year is 3%, what is the annual real rate of return on the bond? (Assume annual interest payments.) (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places. Negative amount should be indicated by a minus sign.)

Answer 1

a. Price of the bond is calculated using excel PV function as in =PV(rate,nper,pmt,fv) where rate =0.101, nper =9, PMT =79 and FV =1000

Price of the bond on year later =PV(0.101,9,79,1000) = $873.80

b. Annual rate of return = Price after one year - purchase price + annual coupon = 873.80-1110+79 = -157.2

Annual rate of return = -157.2/1110 = -14.16%

Annual rate of return -14.16%(Negative)

c. If interest is paid semi annual rate of return is Slightly less than your part b answer

d. If inflation is 3%

Real rate = (Nominal - inflation)/(1+inflation ) = (-0.1416-0.03)/(1+0.03) = -1666 = -16.66%

Annual real rate on bond = -16.66% (Negative)