Question

Suppose that on Jan. 1 2018 you bought a bond at par with the following characteristics: Face Value = $20,000 Coupon rate = 4% Maturity Date = Jan. 1 2020 (2 points) How much did you pay for the bond? (4 points) Calculate your 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. Question 5 options:

Answer 1

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:

* How much did you pay for the bond?

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.

* 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:

+ 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%