Question

Best Buy’s bonds are selling at 95% of face value, mature in 9 years, have a face value of $1,000, and make an annual coupon interest payment of $30. If you buy the bond today and hold it until maturity what will be your return assuming the company does not default and the bond are not called early?

a. 5.11%
b. 6.44%
c. 4.88%
d. 3.66%

Answer 1

The total return on the Best Buy bond when held to maturity, including interest payments and capital gains, can be estimated to be closest to 6.44% annually, assuming no default or early call.

Step-by-step explanation:

To calculate the total return when holding the Best Buy bond until maturity, both the interest payments and the capital gains must be considered. The bond is purchased at 95% of its face value, meaning it is bought for $950 (95% of $1,000). Over the 9-year period, annual coupon payments of $30 will be received, amounting to a total of $270. At maturity, the investor will also receive the face value of $1,000. Therefore, the total amount received is $1,270 ($1,000 + $270).

To calculate the yield or total return of the bond, the formula is (Total returns - Cost) / Cost = Yield. So here, the calculation would be ($1,270 - $950) / $950 = 33.68% over 9 years. To find the annual return, we take the ninth root of the total return (1+0.3368)^(1/9) - 1, which gives us an approximate annual return. Without precisely calculating, we can estimate that the return is closest to option b, 6.44%, based on the choices provided.