Question

Consider a corporate bond with the face value of $1,000, the coupon rate of 8% per annum, paying coupons annually and the remaining term to maturity of 6 years. The current required yield-to-maturity of this bond is 6% per annum. Suppose an investor buys one bond and holds it for two years. At the end of year 2, required yield-to-maturity is expected to rise from 6% to 7% per annum. Find the investor's annual rate of return over his/her 2-year holding period.

Answer 1

Bond Face Value = $1,000

Coupon Rate = 8% annually

When time to maturity = 6 years

YTM = 6%

Calculating Present Value,

Using TVM Calculation,

PV = [FV = 1000, T = 6, PMT = 80, I = 0.06]

PV = $1,098.35

When time to maturity = 4 years

YTM = 7%

Calculating Present Value,

Using TVM Calculation,

PV = [FV = 1000, T = 4, PMT = 80, I = 0.07]

PV = $1,033.87

Calculating Holding Period Return,

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

Holding Period Return = (1033.87 - 1098.35 + 2*80)/1098.35

Holding Period Return = 8.70%

Annual Return = (1.087)^1/2 - 1

Annual Return = 4.26%