(Q5 IN TYPE B)YOU BOUGHT A BOND WITH A 7% ANNUAL COUPON RATE FOUR...

15. (Q5 in Type B)You bought a bond with a 7% annual coupon rate four years ago when market interest rates for similar bonds was 6%. The bond had an original maturity of 10 years and a par value of $1000. Today, the yield to maturity of the bond has increased to 8% annually. If you sell the bond today, what would be your annual rate of return over the past 4 years? The bond pays coupons semi-annually. Assume coupons are not reinvested. A) 3.50% B) 3.69% C) 7.33% D) 14.77% Solution: A Step 1, Find purchase price of bond 4 years ago, using your calculator: PMT = $35, n = 10 x 2 = 20, I = 6/2 = 3, FV = $1000 COMP PV -> PV = $1074.39 Step 2, find price of bond today, using your calculator: PMT = $35, n = 6 x2 = 12, I = 8/2 = 4, FV = $1000 COMP PV -> PV = $953.07 Step 3: Find Rate of Return over the 4 year holding period = (Coupon Interest + or - Cap gain/loss) Original price paid = (70 x 4) + ($953.07 – 1074.39) = 280 – 121.32 $1074.39 $1074.39 = 0.1477 or 14.77% over 4 years Step 4: Annual rate of return = (1 + .1477) ¼ -1 = 3.50%