Question

6

Suppose you purchase a 3-year, 5-percent coupon bond at par and hold it for two years. During that time, the interest rate falls to 4 percent. Calculate your annual holding period return. Instructions: Enter your response rounded to two decimal places Holding period return A 10-year zero-coupon bond has a yield of 6 percent. Through a series of unfortunate circumstances, expected inflation rises from 2 percent to 3 percent. The face value of the bond is $100 a. Assuming the nominal yield rises in an amount equal to the rise in expected inflation, compute the change in the price of the bond. Instructions: Enter your responses to the nearest penny (two decimal places) Price (with 2% expected inflation) = $ { Price (with 3% expected inflation) = $ [ by $ The price has fallen b. Suppose that expected inflation is still 2 percent, but the probability that it will move to 3 percent has risen. Describe the consequences for the price of the bond inflation risk. Investors will require compensation for taking on additional risk, so the price will There is linareased fall and the yield will rise

Answer 1

step 1: we will find value of bond at the end of two years

	Amount	Discount factor at 4%	Value at beginning of third year
Value of principal	100	0.9615[1/1.04]1	96.15[100*0.9615]
Value of interest	5[100*5%]	0.9615[1/1.04]1	4.8075[5*0.9615]
		Value of bond	100.96$

Value of bond (100.96$) will be higher than par value ( 100$) as market rate (4%) is lower than Bond rate (5%)

Interest on Bond received during two years 100*5% *2 years = 10$

Gain at the end of two years= [100.96 -100$] change in bond value+ 10$ interest

=0.96+10

=10.96$

Holding period return = return / par value

=[10.96$/100$] *10%

=10.96%