Question

Assume you purchase a three-year, 9% coupon bond for $950. Suppose interest rates have remained stable.

1. How much could it be sold for two years later?

2. How much could it be sold for one year later?

3. What is your rate of return out of this investment, if the bond is sold for one year later?

Answer 1

Find the interest rate first

Using financial calculator, enter FV=1000; PV= -950; N=3; PMT=9%*1000=90

Solve for I/Y as 11.05

1. Price of the bond with 1 year left to maturity= Coupon*(1-1/(1+r)^n)/r + FV/(1+r)^n

= 9%*1000*(1-1/(1+11.05%)^1)/11.05%+ 1000/(1+11.05%)^1

= 81.04457452+ 900.4952724

= 981.54

2.

Price of the bond with 2 years left to maturity= Coupon*(1-1/(1+r)^n)/r + FV/(1+r)^n

= 9%*1000*(1-1/(1+11.05%)^2)/11.05%+ 1000/(1+11.05%)^2

= 154.0248307+ 810.8917356

= 964.92

3. rate of return on the investment = (selling price-Initial cost+coupon)/Initial cost

= (964.92-950+90)/950

= 0.1104421053

= 11.04%