Question

A government bond matures in 20 years, makes annual coupon payments of 6.0% and offers a yield of 3.7% annually compounded. Assume face value is $1,000. Suppose that five year later, the bond still yields 2.7%. What return has the bondholder earned over the five years?

Answer 1

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 3.7%

And n is the no of Compounding periods 20 years

Coupon 6%

=

= 1321.04

Value of Bond after 5 years

Value of Bond =

Where r is the discounting rate of a compounding period i.e. 2.7%

And n is the no of Compounding periods 15 years

Coupon 6%

=

= 1402.64

% Return = Coupons + Caital gain / Purcahse PRice

= (60*5) + (1402.64 - 1321.04) / 1321.04

= 381.6 / 1321.04

= 28.89%

Option 2 is correct.

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