Suppose that on January 1, 2013, you purchased a bond with the following charact

Question

Suppose that on January 1, 2013, you purchased a bond with the following characteristics

Face value: $1000, maturity date: January 1, 2015, current yield: 7.5%, price: $850

All underlying work must be shown please

a) What was the coupon payment on this bond?

b) What was the coupon rate?

c) Was the yield to maturity greater or less than the coupon rate? Why?

d) If you sold the bond on January 1, 2014, while market interest rates were 5%, what was your holding period return from this bond?

e) If the bond you sold on January 1, 2014 were no longer maturity, would you have receved higher or lower holding period return? Explain

Explanation / Answer

a) What was the coupon payment on this bond?

Coupon payment on this bond =  price*current yield

Coupon payment on this bond = 850*7.5%

Coupon payment on this bond = $ 63.75

b) What was the coupon rate?

Coupon rate = Coupon payment/Face Value

Coupon rate = 63.75/1000

Coupon rate = 6.375%

c) Was the yield to maturity greater or less than the coupon rate? Why?

Yield to maturity should be greater than the coupon rate because Bond is trading at discount & There is inverse relationship between price & YTM

d) If you sold the bond on January 1, 2014, while market interest rates were 5%, what was your holding period return from this bond?

Price of Bond on January 1, 2014 = 63.75/1.05 + 1000/1.05

Price of Bond on January 1, 2014 = $ 1013.10

Holding period return from this bond = (Price of Bond on January 1, 2014 - Price of Bond on January 1, 2013 + Coupon)/Price of Bond on January 1, 2013

Holding period return from this bond = (1013.10-850+63.75)/850

Holding period return from this bond = 26.69%

e) If the bond you sold on January 1, 2014 were no longer maturity, would you have receved higher or lower holding period return? Explain

If the bond you sold on January 1, 2014 were no longer maturity than lower holding period return from point d , since Price of Bond in point d is 1013.10 where in this case price of Bond would be $ 1000 which is lower and hence the holding period return would also be lower

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