Question

You decide to purchase a bond issued by Wing Oh which carries a 7% annual coupon rate and has a 15-year to maturity. The bond’s face value is $1,000. One year from now, the yield to maturity on this bonds is 6.4%. What is the capital gains yield and total rate of return that you realize on this bond over this one-year period?

Answer 1

Answer: Capital gain yield = Change in bond price / Initial price paid for bonds Change in bond price Initial price paid for bonds Capital gain yield $54.41 [Ref: Workings] $1,000 5.44% ($54.41 / $0) x 100) Total rate of return (Holding Period Return) = (Change in Bond Price + Annual Coupon Payments Received) / Initial Price paid for bonds Change in bond price Annual coupon payments received Initial price paid for bonds Total rate of return $54.41 [Ref: Workings] $70 ($1,000 x 7%] $1,000 12.44% ($54.41 + $70) / $1000) x 100 = ($124.41 / $1000) x 100 = 12.44%] Workings: Annual Yield to Maturity, RATE # of Years to Maturity, NPER Annual coupons, PMT Bond's Maturity Value at the end, FV Annual coupon type, TYPE Bond Price after 1 year from now 6.4% 14 [15 years minus 1 year = 14 years --> As 1 year would be expired out of 15 years to maturity] $70 ($1,000 x 7%] $1,000 (Par value recievable at the end] 0 = 0 if coupons paid at the end of each period; 1 if coupons paid at the beginning of each period. $1,054.41 [Ref: NOTE]

Therefore, change in bond price $54.41 ($1054.41 - $1000] NOTE: Bond Price after 1 year from now is calculated using EXCEL FUNCTION PV(rate,nper,pmt,fv,type) where rate=6.4%; nper=14; pmt=-70; fv=-1000; type=0; Here, pmt & fv are negative as they denote cash inflow; type=0 as coupons are paid at the end of each year only. Α в C D E F G H I J K 1 Annual Yield to Maturity, RATE 6.4% 2 # of Years to Maturity, NPER =15-1 [15 years minus 1 year = 14 years --> As 1 year would be expired out of 15 years to maturity] 3 Annual coupons, PMT =1000*7% ($1,000 x 7%] 4 Bond's Maturity Value at the end, FV $1,000 (Par value recievable at the end] 5 Annual coupon type, TYPE 0 = 0 if coupons paid at the end of each period; 1 if coupons paid at the beginning of each period. 6 Bond Price after 1 year from now =PV(B1,B2,-B3,-B4,B5) (Ref: NOTE]