Question

You buy a 12-year 10 percent annual coupon bond at par value, $1,000. You sell the bond three years later for $1,100. What is your rate of return over this three-year period?

a. 40 percent
b. 10 percent
c. 20 percent
d. 30 percent

Answer 1

The rate of return when buying a 12-year 10 percent coupon bond at par value and selling it after three years is calculated by summing up the interest payments and the capital gain. With a total return of 400 dollars on an initial investment of 1000 dollars, the rate of return is 40 percent.

Step-by-step explanation:

To calculate the rate of return over a three-year period for a bond bought at par value and sold before maturity, we consider both the interest payments (coupon payments) and the capital gains (the increase in the price of the bond).

• You buy a bond at 1000 dollars.
• Each year, you receive 10 percent of the par value, which is 100 dollars (annual coupon payment).
• After three years, you sell the bond for 1100 dollars, realizing a capital gain of 100 dollars.

The total income over three years from this bond is the sum of three years of interest payments plus the capital gain, which is (100 dollars * 3) + 100 dollars capital gain = 400 dollars total return.

Your initial investment was 1000 dollars, and your total return is 400 dollars. To calculate the rate of return, you divide the total return by the initial investment.

Rate of Return = (Total Return / Initial Investment) * 100 = (400 / 1000) * 100 = 40%

Hence, the correct answer is a. 40 percent.