Price Risk An investor has a one-year time horizon (H=1) He can invest in three

Question

Price Risk

An investor has a one-year time horizon (H=1)
He can invest in three different zero coupon bonds:
1) 1-year-zero-coupon bond
2) 5-year-zero-coupon bond
3) 10-year zero-coupon bond

The current level of the interest rate is equal to 5% per year. During the first year, the interest rate rises from 5 to 10% per year (stays constant afterwards)

What is the annual realized return of the three bonds?

Present Value Coefficients
Year 1 2 3 4 5 6 7 8 9 10
5% 0,95 0,91 0,86 0,82 0,78 0,74 0,71 0,68 0,64 0,61
10% 0,91 0,83 0,75 0,68 0,62 0,56 0,51 0,47 0,42 0,38

Explanation / Answer

Here, annual realised return = (Vt/V0)^1/t - 1
V0 face value of the bond, take the face value of the bond is $1,000.
Time period is 10 years.
For the first year the interest rate is 5%, after that it is 10%.
For the first year annual payment is = 0.05*1000
= $50
Then after, it is 10%. Coupon payment is $100.
For finding annual realized return, here we have to calculate the Vt.
Vt is must be account for reinvestment of annual coupon $50 and $100.
These reinvestments are as follows.
year1
Year2
Year3
Year4
Year5
…
Year9
Reinvest
Year10
1st coupon
$50
*0.61
$ 30.5
5th year coupon
$100
*0.62
$62
10th year coupon + Principal
$100
*0.91
$91
1000

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.