Question

A bond is selling for $934.74. The coupon rate is 8%. It has ten-years until maturity, with semi-annual compounding.

1. Assume that the re-investment/interest rate has changed to 10%. Calculate the realized compound yield at a re-investment rate of 10%.

2. If an investor wanted to maximize the rate of return, what would you advise the investor to do—sell or hold the bond? Why?

Answer 1

Here Principal amount= $934.74 Interest rate= 8% Number of times money is compounted= 10*2=20

Divide 8% by 2 and convert it to decimal= 8%/2= 4%

=0.04

A= P [(1+I) ^n-1]

A= $934.74 [(1+0.04 ) ^ 20-1]

A=$934.74 * 2.1 =1963

A= $1963

when reinvestment rate changed to 10%

divide 10% by 2 and convert it to decimal =10% /2=5%

=0.05

A= P [(1+I) ^n-1]

A= $934.74 [(1+0.05 ) ^ 20-1]

A=$934.74 * 2.5 =2336.9

A= $2336.9

In order to maximise the rate of return the investor has to hold the bond because the investor will get high return when it will be reinvested