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19 November, 14:40

Suppose that today you buy a bond with an annual coupon of 6 percent for $1,080. the bond has 13 years to maturity. what rate of return do you expect to earn on your investment? assume a par value of $1,000. (do not round intermediate calculations. enter your answer as a percent rounded to 2 decimal places,

e. g., 32.16.)

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  1. 19 November, 14:54
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    Assuming the bond has a par value of $1,000 and pays semi-annually, the BEY (equivalent bond yield) when you bought it was 5.14828%

    [Do an IRR calculation: CF0: (1,080), 25 cash flows of 1,000*0.03 = 30, and a final cash flow of par + coupon $1,030. Double that IRR to reflect BEY on an annual basis.]

    So, if YTM falls to 4.14828% ...

    0.0414828 / 2 = 0.02074
    Price = sum of the discounted cash flows.

    PV of the coupons, use PV ordinary annuity

    n = (13 - 2) * 2 = 22 semi-annual periods remain

    PVoa = PMT[ (1 - (1 / (1 + r) ^n)) / r]

    = 30[ (1 - (1 / 1.02074^22)) / 0.02074]

    = 30[ (1 - 0.63658) / 0.02074]

    = 30[17.52141]

    = 525.64

    PV of par: 1,000 / 1.02074^22 = 636.58137

    Sum PV coupons + PV Par = Price = $1,162.22

    Notice the bond sells at a premium b/c the coupon rate is higher than the market (discount) rate. Some "value" has been added b/c of the "pull to par" - less time until you collect par at the maturity date.

    HPY = [ (coupons collected + sale price) / purchase price] - 1

    coupons for 2 years = 4 * 30 = 120

    HPY = [ (120 + 1162.22) / 1080] - 1

    = 0.18724, or 18.72%
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