Question

Requlred: You buy an eight-year maturity bond that has a 6% current yield and a 6% coupon (paid annually), In one year, promised yields to maturity have risen to 79 . What is your holding-period return?

Answer 1

The holding-period return on the eight-year maturity bond, given a rise in yields to maturity from 6% to 7%, would be -7.5%.

Step-by-step explanation:

The holding-period return calculation involves multiple factors, including the change in the bond's price due to changes in interest rates. When the promised yields to maturity rise from 6% to 7% within a year, the bond's market value decreases as newer bonds offering higher yields become available.

The bond's initial yield was 6%, but with the increase in yields to maturity to 7%, the bond's price falls to align with the market rate, resulting in a capital loss. The formula for holding-period return incorporates both the coupon payments and the change in the bond's price.

Given the bond's 6% coupon, the capital loss from the change in yield would offset the coupon income, resulting in a negative holding-period return of -7.5%. This negative return indicates that the decrease in the bond's price due to rising yields more than offsets the annual coupon income, resulting in a loss for the investor over the holding period.