Question

A year ago, you purchased a 5-year bond, paying fixed annual coupons at a rate 5%pa. At the time you purchased the bond, the yield to maturity was 5%pa. If you sold the bond after receiving the first interest payment and the bond's yield to maturity had changed to 4%, your annual total rate of return on holding the bond for that year would have been approximately 8.1% 4.8% 7.6% 9.5% 8.6%

Answer 1

Option (E).

Assuming face value of $100,

Annual coupon = $100 x 5% = $5

Purchase price a year ago ($) = 5 x P/A(5%, 5) + 100 x P/F(5%, 5) = 5 x 4.3295 + 100 x 0.7835

= 21.65 + 78.35

= 100

Purchase price now ($) = 5 x P/A(4%, 4) + 100 x P/F(4%, 4) = 5 x 4.6299 + 100 x 0.8548

= 23.15 + 85.48

= 108.63

Rate of return = (108.63 / 100) - 1 = 1.0863 - 1 = 0.0863 = 8.63%

NOTE: The answer will be unchanged for any value of the bond's face value.