Question

You purchased an annual interest coupon bond one year ago with 6 years remaining to maturity at the time of purchase. The coupon interest rate is 10% and par value is $1,000. At the time you purchased the bond, the yield to maturity was 8%. If you sold the bond after receiving the first interest payment and the bond's yield to maturity had changed to 7%, your annual total rate of return on holding the bond for that year would have been

Answer 1

Answer:

The total return is 12%

Explanation:

First and foremost we need to establish the bond price now, which is present value of cash flows (all coupon payments and repayment of principal) till maturity.

In calculating the price of the bond , I multiplied the discount factor by the cash flows.

The discount factor is 1/(1+r)^-N,where r is the yield to maturity and N is the number of years to maturity taken as 6 years previously and 5 years now.

N is the relevant year the cash flow is received .

The initial price at which bond is bought is  $1,092.46  (as calculated in the attached)

The price the bond is sold now is $  1,123.01  ( as calculated in the attached)  

the total return=(selling price now+coupon received)/ initial purchase price

the total return =($1,123.01 +$100)/$ 1,092.46 -1

                          =1.12-1

                          =12%

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