Question

Suppose that an investor with a five-year investment horizon is considering purchasing a seven-year 9% (annual rate) coupon bond selling at par. The investor expects that he can reinvest the coupon payments at an annual interest rate of 9.4% and that at the end of the investment horizon two-year bonds will be selling to offer a yield to maturity of 11.2%. What is the total return for this bond? Assume semiannual coupon payments.

Answer 1

For calculating the total return on this bond we need to find out the future value of coupon received
and price received at the end of five years.
PMT	45	1000*0.09/2
Rate	4.70%	9.4%/2
NPER	10	(5 x 2)
FV of coupon	$558.14
	FV(4.7%,10,-45)
Market value of bond after 5 years for 2 years remaining maturity of bonds
PV5	?
FV	1000
PMT	45
NPER	4	(2 x 2)
Rate	5.60%	11.2%/2
PV5	$961.53
	PV(5.6%,4,-45,-1000)
Total value received at end of 5 years (558.14+961.53) = $1,519.67
Return received = (1519.67/1000)^(1/10)-1
	0.042737348	for 6 months
X 2	8.55%	Annually
So return earned is 8.55%