The YTM on a bond is the interest rate you earn on your investment if interest r

Question

The YTM on a bond is the interest rate you earn on your investment if interest rates don’t change. If you actually sell the bond before it matures, your realized return is known as the holding period yield (HPY). a. Suppose that today you buy a bond with an annual coupon of 11 percent for $1,130. The bond has 18 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.) Expected rate of return 9.47 % b1. Two years from now, the YTM on your bond has declined by 1 percent, and you decide to sell. What price will your bond sell for? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Bond price $ b2. What is the HPY on your investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) HPY

Explanation / Answer

a) Rate of return can be calculated using I/Y function on a calculator or RATE function in excel

N = 18, PMT = 11% x 1000 = 110, PV = -1130, FV = 1000 => Compute I/Y = 9.47%

b1) After two years, bond price can be calculated using PV function

N = 16, PMT =110, I/Y = 9.47% - 1% = 8.47%, FV = 1000 => Compute PV = $1,217.51

b2) HPY = (Sell Price - Buy Price + Coupons) / Buy Price = (1217.51 - 1130 + 110 x 2) / 1130 = 27.21%

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