Question

1. Suppose that an investor with a 10-year investment horizon is considering purchasing Bond A, a 15-year 8% semiannual coupon bond selling at par. The investor expects to be able to reinvest the coupon payments at a rate of 7.4% over the first six years and then at a rate of 7.8% over the subsequent four years, and that at the end of the investment horizon, similar 5-year 8% semiannual coupon bonds will be selling to offer a yield of 7% while similar 10-year 8% semiannual coupon bonds will be selling to offer a yield of 7.6%. What is the total return for Bond A?

Answer 1

Assume price of the share is 1000

For 7.4%

0-1/2-1-3/2-2-5/2-3-7/2-4-9/2-5-11/2-6(Years)

40-40-40-40-40-40-40-40-40-40-40-40(at 7.4%)

At the end of 6 years =590.79

Now for 13/2-7-15/2-8-17/2-9-19/2-10(Years)

At the end of 4 years =367.26

and 590.79 at 7.4% becomes= 786.05

Total = 1153.31----------------<1>

Now to sell at end of 10 years

Similarly bond 5 years 8% semi annual and 7% yield

price= 1041.58---------------------<2>

Total value of end of 10 year

<1>+<2>= 2194.89

Return = (2195-1000)/10000*100=119.5%=120%