Question

An investor buys a 9-year, 6.9% annual coupon bond at par ($100). After the purchase and before the first coupon is received, interest rates increase to 8.9% (assume a flat spot rate curve). The investor sells the bond after 7 years (right after receiving the 7th coupon payment). What is this investor's realized annual return in these 7 years?

Assume annual compounding, and that interest rates remain at 8.9% over the entire holding period.

Answer 1

Given about a bond,

Investor purchase a 9 year bond at par value.

Som purchase price = $100

coupon rate = 6.9% annually,

=> annual coupon payment = 6.9% of 100 = $6.9

he sold the bond after 7 years, when interest rate were 8.9%

So, price of bond after 7 years is calculated using formul

PV = C/(1+r) + (FV+C)/(1+r)^2 = 6.9/1.089 + 106.9/1.089^2 = $96.48

So, he sold the bond after 7 years at $96.48.

Realised return can be calculated on financial calculator using following values:

FV = 96.48

PV = -100

N = 7

PMT = 6.9

compute for I/Y, we get I/Y = 6.49%

So, realised return on the bond is 6.49%