Answer:
* How much did you pay for the bond?
20,000
* Rate of return if you hold the bond for a year and then sell it, assuming the market interest rate rises by 1 percentage point from the date when you bought the bond is:
3.05%
Explanation:
<u>* How much did you pay for the bond?</u>
Because the bond is bought at par, the amount paid for the bond will be equal to the face value of the bond or $20,000.
<u>* Rate of return if you hold the bond for a year and then sell it, assuming the market interest rate rises by 1 percentage point from the date when you bought the bond is: 3.05% which is calculated as below:</u>
+ Price of the bond of the time of selling is equal to the sum of present value of two future cash flows happening in 1 year time from the bond, discounting at the current market rate which is 5%, which are:
. Bond's face value: $20,000 in one-year time => PV = 20,000/1.05 = 19,047.62
. Coupon: 20,000 * 4% = $800 in one-year time => PV = 800/1.05 = $761.90
=> Price of the bond = 19,047.62 + 761.90 = $19,809.52
+ Total receipt from holding the bond for one year = Selling price of the bond + coupon received for one-year holding = 19,809.52 + 800 = $20,609.52
=>Rate of return = Total receipt from holding the bond for one year/ the amount paid for the bond at the beginning = 20,609.52 / 20,000 = 3.05%
