Question

The YTM on a bond is the interest rate you earn on your investment if interest rates don’t change. If you actually sell the bond before it matures, your realized return is known as the holding period yield (HPY).

a.	Suppose that today you buy a bond with an annual coupon of 6 percent for $1,150. The bond has 20 years to maturity. What rate of return do you expect to earn on your investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b-1.	Two years from now, the YTM on your bond has declined by 1 percent and you decide to sell. What price will your bond sell for? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b-2.	What is the HPY on your investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

a.

Bond Coupon Rate = 6% annually

Time Period = 20 years

Bond Present Value = $1,150

Bond Par Value = $1,000

Calculating YTM of Bond,

Using TVM Calculation,

I = [PV = 1150, FV = 1000, T = 20, PMT = 60]

I = 0.0482

So,

Return Earned on Investment in Bond = 4.82%

b-1.

After 2 years, if YTM decreased by 1%

YTM = 3.82%

Time Period = 18 years

Calculating Value of Bond,

Using TVM Calculation,

PV = [FV = 1000, PMT = 60, T = 18, I = 0.0382]

PV = $1,280.05

Price of Bond = $1,280.05

b-2.

Holding Period Return = ((Final Value - Initial Value) + Coupon)/Initial Value

Holding Period Return = ((1280.05 - 1150) + 2(60))/1150

Holding Period Return = 21.74%

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