Question

At the beginning of the year, Brandon purchased a 3- year bond that pays an annual coupon of $100 and a principal of $1000 after three years. The yield to maturity was 4%.

a. At the end of the first year (after the payment of the coupon) the price was $1100. Calculate the investor’s holding period return.

b. Calculate the holding period return if the investor sold the bond right before the coupon payments. Note, the bond price is still $1100 at the end of the first year.

Answer 1

Period	Cash Flow	Discounting Factor [1/(1.04^year)]	PV of Cash Flows (cash flows*discounting factor)
1	100	0.961538462	96.15384615
2	100	0.924556213	92.4556213
3	100	0.888996359	88.89963587
3	1000	0.888996359	888.9963587
		Price of the Bond = Sum of PVs	1166.505462

Therefore, Bond was purchased at $1166.51

a) Holding Period Return = [Selling Price-Purchase Price+Coupon Received]/Purchase Price = [1100-1166.51+100]/1000 = 33.49/1000 = 0.03349 = 3.349%

b) Holding Period Return = [Selling Price-Purchase Price+Coupon Received]/Purchase Price = [1100-1166.51+0]/1000 = -66.51/1000 = -0.06651 = -6.651%