Question

Calculate the price of a 5% coupon, $1000 face value, 20-year bond that pays annual coupons if the appropriate annual discount rate is 3%. Suppose the annual discount rate on this bond rises to 7% after three years (at the beginning of year 4) and you sell the bond at the end of that year (at the end of year 4). What return did you earn for the four years that you held this bond? Do not use excel or a finance calculator. Please show all work.

Answer 1

  

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Value of Bond =

Where r is the discounting rate of a compounding period i.e. 3%

And n is the no of Compounding periods 20 years

Coupon 5%

=

= 1297.55

Value after 4 years

Value of Bond =

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

And n is the no of Compounding periods 16 years

Coupon 5%

=

= 811.07

Holding period Return = Coupon + Capital Gain / Purcahse Price

= 50 * 4 + (811.07 - 1297.55 ) / 1297.55

= -22.08%

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