Answer:
Explanation:
a) PV=$1000
As price is equal to face value then the Coupon rate will be equal to its YTM, 10%.
Annual Coupons = 10% * 1000 = $100
b.) We have purchased the bond for $1000, so our investment is $1000
At the end of the year 1, we get a coupon of $100 and the selling price.
1st CASE - When monetary policy is tight.
New YTM = 12%
Time left to maturity (n) = 4 years
Coupon payment = $100
Price = Coupon payment X PVAF(YTM, n) + Face Value X PVF(YTM, n)
[USE TABLES or Financial calculator]
Price = 100 X PVAF(12%, 4) + 1000 X PVF(12%, 4) = 100 X 3.307 + 1000 X .636 = 303.7 + 636 = $939.7
If we sell the bond, Return = (Coupon Received + Selling price - Purchase price ) \div Purchase price
= (100 + 939.7 - 1000) \div 1000 = .0397 or 3.97%
Scenario 2 - When monetory policy is loose
New YTM = 8%
Time left to maturity (n) = 4 years
Coupon payment = $100
Therefore, Price = Coupon payment X PVAF(YTM, n) + Face Value X PVF(YTM, n)
Price = 100 X PVAF(8%, 4) + 1000 X PVF(8%, 4) = 100 X 3.312 + 1000 X .735 = 331.2 + 735 = $1066.2
If we sell the bond, Return = (Coupon Received + Selling price - Purchase price ) \div Purchase price
= (100 + 1066.2 - 1000) \div 1000 = .1662 or 16.62%
