Question

Problem 7-30 Holding Period Yield [LO2] The YTM on a bond is the interest rate you earn on your investment if interest rates don't change. If you actually sell the bond before it matures, your realized return is known as the holding period yield (HPY). a. Suppose that today you buy a bond with an annual coupon of 8 percent for $1,030. The bond has 17 years to maturity. What rate of return do you expect to earn on your investment? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Expected rate of return b1. Two years from now, the YTM on your bond has declined by 1 percent, and you decide to sell. What price will your bond sell for? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16) Bond price b2. What is the HPY on your investment? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) HPY

Answer 1

Answer a:

Face value = $1,000

Annual coupon = $1,000 * 8% = $80

Purchase price = $1,030

Years to maturity = 17 years

To get expected rate of return, we will use excel function RATE:

RATE (nper, pmt, pv, fv, type)

RATE (17, 80, -1030, 1000, 0)

= 7.67814 or 7.67%

Expected rate of return 7.68 %

Answer b1:

YTM is declined by 1%

YTM = 7.67814% - 1% = 6.67814%

To calculate price we will use PV function of excel:

PV (rate, nper, pmt, fv, type)

PV (6.67814%, 15, -80, -1000, 0)

=$1,122.8801 or $1,122.88

Bond Price $1,122.88

Answer c:

Purchase price = $1,030

Sale price = $1,122.88

Period = 2

Holding period return =

RATE (2, 80, -1030, 1122.88, 0)

=12.02%

HPY 12.02 %