Question

An investor is considering the purchase of a(n) 8.125% 18 year corporate bond that;s being priced...

An investor is considering the purchase of a(n) 8.125% 18 year corporate bond that;s being priced to yield 10.125%. She thinks that in a year, the bond will be priced in the market to yield 9.125%. Using annual compounding, find the price of the bond today and in 1 year. Next, find the holding period return on this investment, assuming that the investor's expectations are borne out.

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Answer #1

Price of bond today is equal to present value of all future coupon payments as well as principal amount

Let the face value be 1000

Price of bond today = 1000*8.125%*PVAF(10.125%, 18 years)+ 1,000*PVF(10.125%, 18 years)

= 81.25*8.07163+ 1000*0.172657

= $828.48

Price of bond one year from today = 81.25*PVAF(9.125%, 18 years) + 1000*PVF(9.125%, 18 years)

= 81.25*8.68312+1,000*0.207665

=$913.17

Holding period return = (ending price - beginning price) + coupon payment

= {(913.17-828.48)+81.25}/828.48

= 20.03%

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