Question

A 20-year maturity corporate bond has a 6.5% coupon rate (the coupons are paid annually). The bond currently sells for $925.50. A bond market analyst forecasts that in 5 years yields on such bonds will be at 7%. You believe that you will be able to reinvest the coupons earned over the next 5 years at a 6% rate of return. What is your expected annual compound rate of return if you plan on selling the bond in 5 years

Answer 1

Answer:

7.37%

Explanation:

First of we calculate Future value of coupon payments:

Annual Payment= 65

Interest = 6%

Time = 5 years

Present value = 0

Future value = 65 + 65 * (1.06) + 65 * (1.06)^2 + 65 * (1.06)^3 + 65 * (1.06)^4

Future value = 366.41

Now after 5 years the interest rate will become 7%, we will calculate present value of bond after 5 years:

Annual Payment= 65

Interest = 7%

Time = 15 years

Present value = 65/ (1.07) + 65/ (1.07)^2 + .......+ 65/(1.07)^15 + 1000/ (1.07)^15

Present value = 954.46

Total future value = 954.46 + 366.41 = 1,320.87

($925.50) * (1 + r)^5 = $1,320.87

r = 7.37%