Final answer:
To calculate the rate of return for selling a 10-year, 7% coupon bond next year for $880.10, considering its current selling price of $871.65, add the $70 interest (from the 7% coupon) to the $8.45 capital gain, then divide by the purchase price and multiply by 100. The rate of return would be approximately 8.99%.
Step-by-step explanation:
The question is about calculating the rate of return on a 10-year, 7% coupon bond with a face value of $1,000 that is currently selling for $871.65. If you sell the bond next year for $880.10, to compute the rate of return, you must account for the interest earned plus the capital gain or loss on the bond (difference between the selling price and the purchase price).
You purchased the bond for $871.65 and will sell it for $880.10. During the year, you would have also received a coupon payment. Since the bond has a 7% coupon rate, your interest payment for the year would be 7% of $1,000, which is $70. Therefore, your total return would be the $70 of interest plus the $8.45 increase in the bond's value ($880.10 - $871.65).
To calculate the rate of return, you would divide the total return by the initial purchase price of the bond to get your percentage yield. Here's the calculation:
Total Return = Interest + Capital Gain
= $70 + ($880.10 - $871.65)
= $70 + $8.45
= $78.45
Rate of Return = (Total Return / Purchase Price) * 100
= ($78.45 / $871.65) * 100
= 8.99%
Therefore, the rate of return if you sell the bond next year for $880.10 would be approximately 8.99%.