Question

At the beginning of the? year, you bought a ?$1000 par value corporate bond with an annual coupon rate of 13 percent and a maturity date of 12 years. When you bought the? bond, it had an expected yield to maturity of 12 percent. Today the bond sells for ?$1200.

a. What did you pay for the? bond?

b. If you sold the bond at the end of the? year, what would be your? one-period return on the? investment? Assume that you did not receive any interest payment during the holding period.

Answer #1

a) Bond Valuation: The fair price of bond is the present value of the expected cashflows from the bond,discounted at Yield to Maturity(YTM).

Year |
Cash flow |
PVAF/PVF@12% |
Present Value
(Cashflow*PVAF/PVF) |

1-12 | 130 | 6.194 | 805.22 |

12 | 1000 | 0.257 | 257.00 |

**Fair price on Bond =
$1062.22** (805.22+257)

Hence we pay maximum $1062.22 to buy bond.

b. Return on an investment comprises of two elements - Capital gain (change in market price) and interest payment. In the given instance, since the question specifically states that we did not receive any interest payment during the holding period. Hence return on investment comprise only change in market price.

Return on investment = (Sale value - cost of acquisition) / cost of acquisition

= (1200 - 1062.22) / 1062.22

= 137.78 / 1062.22

= .1297

= 12.97%

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