It is now the beginning of a year. Jared is considering the purchase of a 7.5 pe

Question

It is now the beginning of a year. Jared is considering the purchase of a 7.5 percent (coupon rate), 15-year bond that is presently priced to yield 11 percent (i.e. market interest rate is 11 percent). Based on extensive analysis of market interest rates, he thinks rates will fall so that at the end of this year the market yield of this issue will drop to 9 percent. If his expectations are correct, what kind of realized return will Jared earn by purchasing the bond today and selling the bond at the end of the year? (Assuming annual interest payments)

a) 26.74%

b) 18.03%

c) 25.07%

d) 28.05%

e) 23.95%

Explanation / Answer

Face value (FV) $                                   1,000.00 Coupon rate 7.50% Number of compounding periods per year 1 Interest per period (PMT) $                                         75.00 Number of years to maturity 15 Number of compounding periods till maturity (NPER) 15 Market rate of return/Required rate of return 11.00% Market rate of return/Required rate of return per period (RATE) 11.00% Bond price PV(RATE,NPER,PMT,FV)*-1 Bond price $                                       748.32 Face value (FV) $                                   1,000.00 Coupon rate 7.50% Number of compounding periods per year 1 Interest per period (PMT) $                                         75.00 Number of years to maturity 14 Number of compounding periods till maturity (NPER) 14 Market rate of return/Required rate of return 9.00% Market rate of return/Required rate of return per period (RATE) 9.00% Bond price PV(RATE,NPER,PMT,FV)*-1 Bond price $                                       883.21 Bond purchase price $                                       748.32 Realised return 28.05% (883.21-748.32+75)/748.32

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