Question

Suppose you purchase a 30-year, zero-coupon bond with a yield to maturity of 6.3%. You hold the bond for five years before selling it a. If the bond's yield to maturity is 6.3% when you sell it, what is the annualized rate of return of your investment? b. If the bond's yield to maturity is 7.3% when you sell it, what is the annualized rate of return of your investment? c. If the bond's yield to maturity is 5.3% when you sell it, what is the annualized rate of return of your investment? d. Even if a bond has no chance of default, is your investment risk free if you plan to sell it before it matures? Explain.

Answer 1

Bond life = 30 years

Holding period = 25 years

YTM(Buy) = 6.3%

a.

YTM(Sell) = 6.3%

Annualized rate of return on investment = (6.3 - 6.3 ) / 25 * 100

= 0%

b.

YTM(Sell) = 7.3%

Annualized rate of return on investment = (7.3 - 6.3 ) / 25 * 100

= 4%

c.

YTM(Sell) = 5.3%

Annualized rate of return on investment = (5.3 - 6.3 ) / 25 * 100

= -4%

d.

Zero coupon bond risk free rate always zero.

Hence,investment is risk free