You have just purchased a 5-year coupon bond paying a coupon rate of 5% per year

Question

You have just purchased a 5-year coupon bond paying a coupon rate of 5% per year quarterly with a yield to maturity of 11% and a face value of $1,000. a. Find the bond's price today and three months from now after the next coupon is paid. b. What would your rate of return if you sell the bond right after receiving the first c What would your rate of return if you sell the bond 30 days after receiving the first Assume the yield to maturity on the bond is 10% after three months. coupon? coupon? The reinvestment rate is 1% for these 30 days (not annualized). Assume that bond's bid and ask prices on the market at this time are Pbid- $733.01 and pask $736.68. The coupon periods has 91 days.

Explanation / Answer

a) To calculate the bond price today, input the following in the financial calculator:

n=4*5=20; FV=1000; 1/y = 11%/4; PMT = 5%*1000/4 = 12.5; calculate PV = $771.59

Now, after 3 months when the coupon is paid, the yield drops to 10%, to calculate the price, input the following in the financial calculator

n=19; FV=1000; 1/y = 10%/4; PMT = 5%*1000/4 = 12.5; calculate PV = $812.76

b) If we bought the bond at 771.59 and sold at $812.76, we would gain 812.76-771.59 = $41.17. We would also receive the first coupon of $12.5 after 3 months. So total gain is $41.17+$12.5 = $53.67, which is gain of 53.67/771.59*100=6.95% which is 1.0695^4-1 = 30.86% annualized.

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