Question

Question 3

1. (a) You purchased the bond 45 days after last coupon payment date. Quoted price of the bond is $970. Face value of the bond is $1,000. Coupon rate is 5% p.a. and there are 182 days in the next semi-annual coupon period. Calculate your holding period percentage return if you sell the bond at $1,025 immediately after receiving the first coupon payment.

2. (b) Explain whether coupon rate or current yield is better for measuring performance of bond investors. (3 marks)

Answer 1

(a).

Income on bond = $1,025 - $1,000

= $25

Holding period return = ((Income + (end value - initial value)) / initial value) * 100.

= [(25 + (1025 - 970)) /970] * 100

= (80/970) * 100

= 8.25%

(b).

Current yeild on bond = (Interest earned ÷ price of bond) * 100

= ( 25 / 970) * 100

= 2.58% semi-annually

Therefore annual current yeild = 2.58% * (365 / 182)

= 5.15%

• Current yeild is the return expressed as a percentage of your original investment.
• Coupon rate is the return calculated and declared by the investee on the face value of the bond.
• The current yeild considers both returns viz. The discount value investor gets on bond subscription plus the interest received on bond. Thus, among coupon rate and current yeild, the current yeild expresses best performance of bond valuation.
• However, the holding period return is yeild to maturity which shows the rate of return investor would get if he holds the bond till maturity. It is the best performance measure of all.