Question

Suppose you buy a bond with a coupon of 7.1 percent today for $1,000. The bond has 16 years to maturity. Two years from now, the YTM on your bond has increased by 2 percent, and you decide to sell. What is the percentage realized rate of return? Assume that interest payments are reinvested at the original YTM. The bond pays coupons twice a year. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Initially, you bought the bond at par value of $1000. Hence, the YTM is 7.1%.

After two years, the YTM increases by 2% to 9.1%

Now we have to calculate the bond price and please remember that the payments are made semi-annually.

=PV(rate,nper,pmt,fv,type)

rate=YTM/2=9.1%/2=4.55%

nper=2*14=28 (14 years left to maturity)

pmt=semi-annual coupon=(7.1%*1000)/2=71/2=35.5

fv=1000

=PV(4.55%,28,35.5,1000,0)=$843.45

The price of the bond becomes $843.45 after two years.

Realized rate of return=(selling price-purcahse price)/Purchase price=($843.45-$1000)/$1000=-15.66%