Question

An 8-year government bond makes annual coupon payments of 5% and offers a yield of 7% annually compounded. suppose that the bond yields 2% at the end of the year. what returns did the bondholder earn in this case?

Answer 1

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 7%

And n is the no of Compounding periods 8

Coupon 5%

=

= 880.74

Value of Bond at year end =

Where r is the discounting rate of a compounding period i.e. 2%

And n is the no of Compounding periods 7

Coupon 5%

=

= 1194.16

Return = Coupon+ Capital Gain

= 50 + (1194.16 - 880.74)

= 363.42

% Return = 363.42 / 880.74

= 41.26%